Dividends Value » IBM

We Were Dividends, Before Dividends Were Cool *

D4L — Wed, 20 Oct 2010 07:30:55 +0000

It seems nowadays that every investing article ends with the same conclusion – you should be buying dividend stocks. They are all quoting studies citing the performance edge that dividends have enjoyed over the long-term and the value of a semi-fixed return generated from periodic dividend payments. However, you should beware of some of the information provided. Beyond the simple concepts, some of the writers are making really bad recommendations and cross-breeding dividend investing with their preferred form of investing.

Dividend growth investing is not about exit points, momentum swings, relative strength, sector rotation; instead it is about studying fundamentals, selecting superior stocks and building a portfolio with a long-term horizon. When we buy a dividend stock, we hope to hold it forever. What makes a good dividend stock? Here are some of the things I look for:

Good Business Model

Sell things that people want or need, and do it in such a way that it is difficult or impossible for others to duplicate. There is a reason that pharmaceutical companies, such as Abbott Laboratories (ABT), are so profitable. With effective drugs under patent that sustain or enhance people’s life these companies have a deep moat. Consumer goods companies like Procter & Gamble Co. (PG) and Kimberly-Clark Corporation (KMB) manufacture products such as soap, detergent and toilet paper that we just can’t do without. Sure, there may be generic substitutes, but over the years many of these products have endeared themselves to consumers who are willing to pay a few cents more for the name brand.

Strong Free Cash Flow

Dividends are paid with cash remaining after paying the operating expenses and replacement capital (free cash flow). If a company has trouble meeting these basic needs, then its dividend is perilously at risk. Companies with a low free cash flow payout (FCF) payout are well-positioned to sustain their dividend. Such companies include: Target Corporation (TGT) at 13.85% FCF Payout, Diebold, Inc. (DBD) at 17.21%, International Business Machines Corp. (IBM) at 19.48% and Walgreen Company (WAG) at 22.71%.

Acceptable Debt Level

Generating a strong free cash flow is not enough – cash has to be available to be paid as dividends. As a result of the economic downturn, many companies are feeling pressure to reduce debt to stay within their covenants and try to maintain their debt rating. If a company’s excess cash is being used to service debt, there may not be any left over to increase dividends. Companies with a low debt to total capital include: T. Rowe Price Group Inc. (TROW) at 0.00% Debt to Total Capital, Automatic Data Processing Inc. (ADP) at 0.69%, Harleysville Group Inc. (HGIC) at 13.19% and Genuine Parts Company (GPC) at 15.76%.

Good Balance between Dividend Yield and Growth

There is usually a reason why a stock’s yield is above average. Often it is the market’s way of saying it doesn’t believe the company can maintain the dividend. Most people understand this risk. However, there is also risk to a stock that has a high dividend growth rate. To maintain a high dividend growth rate the company has to grow cash available for dividends at the same rate. This is often difficult to do. Here are several companies with a good balance between dividend yield and dividend growth rate: The Coca-Cola Company (KO) 2.94% yield and 7.32% dividend growth rate, UGI Corporation (UGI) 3.06% yield and 5.70% growth, The Clorox Company (CLX) 3.24% yield and 9.35% growth, Johnson & Johnson (JNJ) 3.31% yield and 8.42% growth and Corporate Office Properties (OFC) 4.25% yield and 5.22% growth.

For those of us that have invested in dividends for years (decades for some), we know dividend growth investing is not a passing fad to be “played” then move on the next hot investment strategy. Part of me will be glad when dividend investing falls out of favor and the masses moves on.

Full Disclosure: Long ABT, PG, ADP, HGIC, CLX, GP, JNJ, KMB, KO. See a list of all my income holdings here.

(Photo Credit)

10 Dividend Stocks Delivering A Quick Payback *

D4L — Wed, 28 Jul 2010 07:30:05 +0000

Payback is the amount of time needed for an investment to earn its cost, undiscounted. For example, if you buy a dividend stock for $100 that pays a $5 annual dividend, the payback is 20 years (100/5). Though not very sophisticated, payback can still help you screen for good, solid dividend growth stocks. I learned this lesson the hard way…

Years ago as a young analyst, I was assigned the project of streamlining my employers’ acquisition model. As part of this project, I removed the payback calculation. The company’s focus was on discounted cash flow and internal rate of return, so I didn’t see the need for a payback metric. No one noticed the missing payback calculation, that is, no one except the CEO. Needless to say, I was a little nervous making the long walk to the corner office to explain why I had removed a metric that he considered both beneficial and important.

The CEO’s background was not financial, but he had a keen understanding of finance. He was kind in his explanation of how he used payback. When looking at a 40 year project with literally hundreds of assumptions, payback helped him gauge the risk of missing those assumptions. If the assumptions were little aggressive and the payback was 20 years, the project’s sponsor would get a lot of tough questions. A shorter payback and less aggressive assumptions normally indicated a lower risk project.

When applying this concept to dividend growth stocks, the calculation is a little more complicated than simple example above due to the annual dividend increases. Nothing that can’t be quickly modeled in a spreadsheet. I recently added payback as one of the metrics tracked in my database. Companies with a very short payback are often troubled or have been highly discounted due to the market’s lack of faith in them. At the other extreme, do you really want to wait 30, 40 or 50 years to earn back your initial investment?

As a compromise, a 10 to 15 year payback should be acceptable for most long-term investors. Below are several notable companies with a payback falling within that range:

		Current	Dividend
Company	Analysis	Yield	Growth	Payback
P&G (PG)	Link	2.91%	9.87%	14.7
Colgate (CL)	Link	2.43%	12.48%	14.4
IBM Corp. (IBM)	-	1.96%	15.00%	14.4
Abbott Labs (ABT)	Link	3.51%	8.27%	14.2
Kimberly-Clark (KMB)	Link	4.14%	6.67%	13.9
J&J (JNJ)	Link	3.65%	8.42%	13.8
Harleysville (HGIC)	Link	4.21%	8.00%	12.8
Owens & Minor (OMI)	Link	2.56%	15.12%	12.7
AT&T, Inc. (T)	Link	6.50%	2.44%	12.2
McDonald’s (MCD)	Link	3.14%	15.00%	11.6

Once you earn back your investment, some might say you are in a no-lose situation. I wouldn’t go quite that far, but you have found an investment that that has provided you a good historical revenue stream, and hopefully it will continue to do so in the future. Things change, so we must be diligent and watch our investments for fundamental shifts that could be unfavorable to our future income stream.

Full Disclosure: Long PG, CL, ABT, KMB, JNJ, HGIC, T, MCD. See a list of all my income holdings here.

(Photo Credit)

Five Dividend Stocks To Buy On A Dip *

D4L — Wed, 19 May 2010 07:30:56 +0000

Did May 6th frighten or excite you? I received a few emails from frightened dividend investors letting me know they were getting out of the market, while others asked if this was the beginning of another significant downturn. The first group are destined to always lose money in the market (sell low/buy high) and my answer to the second group was, ‘I hope so!’ Let me explain.

As a long-term dividend investor I love buying blue-chip companies when they go on sale and there is no underlying fundamental business reason. If you can buy a Ferrari at the price of a Camaro, most people would consider that a good thing, but for some reason many long-term investors fret whenever there is a major clearance sale on the stocks they want to own.

I keep a list of great stocks that I would love to buy or add to my current position. Here are a few on that list:

Automatic Data Processing, Inc. (ADP) | Yield @ Buy Price: 3.57%
Buy Price: $38.11 | Recent Price: $41.80 | Premium: 9.68% | Analysis

International Business Machines (IBM) | Yield @ Buy Price: 2.18%
Buy Price: $119.11 | Recent Price: $131.19 | Premium: 10.14%

Pepsico, Inc. (PEP) | Yield @ Buy Price: 3.04%
Buy Price: $59.28 | Recent Price: $66.07 | Premium: 11.5%

Genuine Parts Company (GPC) | Yield @ Buy Price: 4.68%
Buy Price: $35.04 | Recent Price: $41.25 | Premium: 17.7% | Analysis

Eaton Vance Corp. (EV) | Yield @ Buy Price: 2.59%
Buy Price: $24.67 | Recent Price: $32.80 | Premium: 32.93%

If the market drops, there is no need to panic if you are a long-term, buy-and-hold investor. While others are content to give away their stocks, I will pull out my wish list and see if any of my targets ready for harvesting.

Full Disclosure: Long ADP, PEP, GPC. See a list of all my income holdings here.

(Photo Credit)

20 Dividend Stocks With A 20% Yield In 20 Years *

D4L — Wed, 05 May 2010 05:01:00 +0000

There are income investors and Dividend Growth investors. While the distinction is rather simple, it slips past many casual observers. Income investors are investing for maximum current income, while dividend growth investors are looking to maximize income over an extended period of time — usually sacrificing current income for potential greater future earnings.

Often when I write about a stock that is yielding 2%, 3% or even 4%, I get a question that goes something like, “Why would you buy that stock when there are better options like ‘Amalgamated Risk?’ Its currently yielding 7%, 8%, 9% or more?” With this statement the reader has possibly identified themselves as an income investor, and but definitely established the fact that they are not a dividend growth investor.

Tracking Yield On Cost

Yield-on-cost (YOC) is simply Current Annual Dividend dividend by Original Cost Per Share. YOC not a substitute for calculating an internal rate of return (IRR). The IRR calculation takes into account both capital appreciation and the timing of cash flows (purchases, sells and dividends). However, as a dividend growth investor, my primary focus is on dividend growth and since my desired holding period is forever, capital appreciation is little more than an interesting side note. YOC is much better suited for tracking dividend growth since it is individually tied to a stock and takes into account all the variations of growth rates over time, along with the timing of purchases. Also, it is useful when trying to explain to our income investor brethren why we chose the stock yielding 3% over ‘Amalgamated Risk’ at 8%.

Recently, I modified my D4L-Data model to include projections of YOC after 5, 10, 15 and 20 years. These projections are derived by growing the current yield using the dividend growth rate. As for the dividend growth rate, I use the minimum of the 1, 3, 5, 7 or 10 year compound annual growth rates; or 15% if in every consecutive 4-year period dividends grew on average in excess of 15%.

20 Dividend Stocks With A 20% Yield In 20 Years

Sorting the stocks in my D4L-Data model by their 20 Year YOC and throwing out some bad apples, we are left with these 20 stocks that are projected to have a 20% YOC in 20 years:

Lowe’s Companies (LOW) | Analysis
- Current Yield: 1.29%
- Dividend Growth: 15.0%
- 20 Year YOC: 21.12%

McGrath RentCorp (MGRC) | Analysis
- Current Yield: 3.32%
- Dividend Growth: 10.26%
- 20 Year YOC: 23.40%

Fastenal Company (FAST)
- Current Yield: 1.46%
- Dividend Growth: 15.00%
- 20 Year YOC: 23.94%

Colgate-Palmolive (CL) | Analysis
- Current Yield: 2.41%
- Dividend Growth: 12.48%
- 20 Year YOC: 25.34%

C.H. Robinson (CHRW)
- Current Yield: 1.61%
- Dividend Growth: 15.00%
- 20 Year YOC: 26.32%

Canadian National (CNI)
- Current Yield: 1.75%
- Dividend Growth: 15.00%
- 20 Year YOC: 28.69%

Walgreen Company (WAG) | Analysis
– Current Yield: 1.57%
- Dividend Growth: 15.72%
- 20 Year YOC: 29.14%

Raven Industries (RAVN) | Analysis
- Current Yield: 1.81%
- Dividend Growth: 15.00%
- 20 Year YOC: 29.65%

Eaton Vance (EV)
- Current Yield: 1.82%
- Dividend Growth: 15.00%
- 20 Year YOC: 29.72%

HCC Insurance (HCC)
- Current Yield: 1.91%
- Dividend Growth: 15.00%
- 20 Year YOC: 31.30%

Becton, Dickinson (BDX) | Analysis
- Current Yield: 1.94%
- Dividend Growth: 15.00%
- 20 Year YOC: 31.72%

IBM (IBM)
- Current Yield: 1.94%
- Dividend Growth: 15.00%
- 20 Year YOC: 31.72%

United Technologies Corp. (UTX) | Analysis
- Current Yield: 2.05%
- Dividend Growth: 15.00%
- 20 Year YOC: 33.63%

Praxair, Inc. (PX)
- Current Yield: 2.15%
- Dividend Growth: 15.00%
- 20 Year YOC: 35.17%

Owens & Minor (OMI)
- Current Yield: 2.25%
- Dividend Growth: 15.12%
- 20 Year YOC: 37.55%

Linear Technology (LLTC)
- Current Yield: 2.93%
- Dividend Growth: 15.00%
- 20 Year YOC: 47.94%

McDonald’s Corp. (MCD) | Analysis
- Current Yield: 3.12%
- Dividend Growth: 15.00%
- 20 Year YOC: 51.01%

Nucor Corporation (NUE) | Analysis
- Current Yield: 3.18%
- Dividend Growth: 15.00%
- 20 Year YOC: 52.00%

Cardinal Health, Inc. (CAH) | Analysis
- Current Yield: 2.02%
- Dividend Growth: 17.65%
- 20 Year YOC: 52.06%

Meridian Bioscien (VIVO) | Analysis
- Current Yield: 3.40%
- Dividend Growth: 15.00%
- 20 Year YOC: 55.67%

One key component of current yield is risk. If Treasuries (risk free) were paying 7%, 8% or 9%, many income investors and a significant number of dividend growth investors would divert a portion of their portfolios to them.

You will note that all the above stocks are yielding well under 4%. It is also important to note that I do not believe that all the above stocks will achieve their 20 year YOC. In much the same way high-yielding stocks often end up cutting their dividends, many of the above stocks will end up cutting their dividend growth rate. Put another way, there is risk associated low-yield high-dividend-growth stocks. However, for the high dividend growth stocks that perform well over the next 20 years, the rewards are potentially much higher than those of a high-yield, low growth stock.

Full Disclosure: Long CNI, UTX, MCD, NUE. See a list of all my income holdings here.

(Photo Credit)

How Often Should A Stock Pay And Raise Dividends? *

D4L — Fri, 30 Apr 2010 10:30:05 +0000

In the U.S. and Canada, most companies pay dividends quarterly. In other parts of the world, it is not uncommon for companies to pay an annual or a semi-annual dividend. That is not to say that North American companies sometimes choose not to pay quarterly dividends. For many years McDonald’s (MCD) paid an annual dividend. Since 2000, Walt Disney Co. (DIS) has paid an annual dividend and Ruby Tuesday, Inc. (RT) pays a semi-annual dividend. Going in the other direction, Realty Income Corp. (O) and Alpine Total Dynamic Dividend Fund (AOD) pay monthly dividends.

Though I prefer quarterly dividends, there is something more important than frequency — dividend increases. Below are several companies satisfying their shareholders desire for more cash by increasing their dividends:

Travelers (TRV) is a leading provider of commercial property-liability and homeowners and auto insurance. April 23rd the company increased its quarterly dividend to $0.36/share. The dividend is payable June 30, 2010, to shareholders of record as of the close of business June 10, 2010. The ex-dividend date is June 8, 2010. The yield based on the new payout is 2.85%.

Costco Wholesale (COST) operates about 565 membership warehouses in the U.S., Puerto Rico, Canada, the U.K., Taiwan, Japan, Korea, and Mexico. April 23rd the company raised its quarterly dividend 14% to $0.205/share. The dividend of $.205 per share is payable May 21, 2010, to shareholders of record at the close of business on May 7, 2010. The ex-dividend date is May 5, 2010. The yield based on the new payout is 1.39%.

Holly Energy Partners (HEP) operates refined product pipeline and terminal facilities. April 23rd the partnership raised its quarterly distribution to $0.815/unit. The distribution will be paid May 14, 2010, to unitholders of record May 4, 2010. The ex-distribution date is April 30, 2010. The yield based on the new payout is 6.98%.

International Paper (IP) is a leading worldwide producer and distributor of printing papers and packaging products. On April 26th the company increased its quarterly dividend to $0.125/share. The dividend is payable June 15, 2010 to shareholders of record on May 17, 2010. The ex-dividend date is May 13, 2010. The yield based on the new payout is 1.85%.

Alliance Holdings GP, L.P. (AHGP) produces and markets coal primarily to utilities and industrial users in the U.S. It offers a range of steam coal with varying sulfur and heat contents. April 26th the partnership increased its quarterly distribution 2.8% to $0.465/unit. The distribution is payable on May 20, 2010, to AHGP’s unitholders of record as of the close of trading on May 13, 2010. The ex-dividend date is May 13, 2010. The yield based on the new payout is 5.49%.

Community Bank System (CBU) provides financial services in upstate New York, and in northeastern Pennsylvania as First Liberty Bank & Trust. April 26th the company raised its quarterly dividend 9.1% to $0.24/share. The dividend is payable on July 9, 2010, to shareholders of record as of June 15, 2010. The ex-dividend date is June 11, 2010. CBU is a Dividend Achiever and has paid a higher dividend for 17 consecutive years. The yield based on the new payout is 3.89%.

Inergy Holdings (NRGP) operates a retail and wholesale propane supply, marketing and distribution business. April 26th the company increases its quarterly distribution 3.7% to $0.975/unit. The distribution will be paid on May 14, 2010, to unitholders of record as of May 7, 2010. The ex distribution date is May 5, 2010. The yield based on the new payout is 5.31%.

EarthLink (ELNK) is one of the largest U.S. Internet service providers, based on paying subscribers. April 27th the company increases it quarterly dividend to $0.16/share. This increase will be reflected in the next quarterly dividend to be paid on June 28, 2010 to shareholders of record on June 14, 2010. The ex-dividend date is June 12, 2010. The yield based on the new payout is 6.88%.

Williams Partners (WPZ) engages in gathering, transporting, processing, and treating natural gas, as well as fractionating and storing natural gas liquids. April 27th the company increases its quarterly distribution 3.5% to $0.66/unit. The distribution is payable on May 14, 2010, to unitholders of record at the close of business on May 7, 2010. The yield based on the new payout is 6.31%.

IBM (IBM) products and services include information technology services, software, computer hardware equipment, fundamental research, and related financing. April 27th the company raised its quarterly dividend 18% to $0.65/share. The dividend is payable June 10, 2010 to stockholders of record May 10, 2010. The ex-dividend date is May 6, 2010. This is the 15th year in a row that IBM has increased its quarterly cash dividend, and 7th year in a row of double-digit percent increases. With the payment of the June 10th dividend, this Dividend Achiever will have paid consecutive quarterly dividends every year since 1916. The yield based on the new payout is 2.02%.

Sunoco Logistics Partners LP (SXL) owns and operates a group of refined product and crude oil pipelines and terminal facilities. April 27th the company increases its quarterly distribution 2.3% to $1.11/unit. The yield based on the new payout is 6.54%.

WW Grainger (GWW) is the largest global distributor of industrial and commercial supplies such as hand tools, electric motors, light bulbs and janitorial items. April 28th the company raised its quarterly dividend 17% to $0.54/share. April 28th the company raised its quarterly dividend 17% to $0.54/share. The dividend is payable on June 1 to shareholders of record on May 10. The ex-dividend date is May 6. GWW is a Dividend Aristocrat and has paid a higher dividend for 39 consecutive years. The yield based on the new payout is 1.99%. See recent analysis.

Exxon (XOM) is the world’s largest publicly owned integrated oil company. April 28th the company raised its quarterly dividend 4.8% to $0.44/share. The dividend is payable on June 10, 2010 to shareholders of record of Common Stock at the close of business on May 13, 2010. XOM is a Dividend Aristocrat and has paid a higher dividend for 28 consecutive years. The yield based on the new payout is 2.54%.

Chevron (CVX) is a global integrated oil company that has interests in exploration, production, refining and marketing, and petrochemicals. April 28th the company increased its quarterly dividend 5.9% to $0.72/share. The dividend is payable June 10, 2010, to holders of common stock as shown on the transfer records of the Corporation at the close of business on May 19, 2010. The ex-dividend date is May 17. The amount represents a 5.9 percent increase in the company’s quarterly dividend. CVX is a Dividend Achiever and has paid a higher dividend for 23 consecutive years. The yield based on the new payout is 3.37%.

Sturm, Ruger & Co. (RGR) designs, manufactures, and sells firearms to domestic customers; it offers products in four industry product categories: rifles, shotguns, pistols, and revolvers. April 28th the company raised its quarterly dividend 55% to $0.093/share. The dividend will be paid on May 28, 2010 to stockholders of record as of May 14, 2010. The ex-dividend date is May 12, 2010. The yield based on the new payout is 2.16%.

TransAlta Corp. (TAC) is an independent power producer and wholesale marketing company owns a portfolio of generation assets in Canada, the United States, Mexico, and Australia. April 29th the company increased its quarterly dividend to $0.29/share. The dividend is payable July 1, 2010 to shareholders of record at the close of business June 1, 2010. The ex-dividend date is May 28, 2010. The yield based on the new payout is 5.59%.

Cullen/Frost Bankers (CFR) is the largest multi-bank holding company headquartered in Texas, has more than 80 offices in various cities in the state. April 29th the company increases its quarterly dividend 4.7% to $0.45/share. The dividend is payable June 15, 2010 to shareholders of record on June 1, 2010. The ex-dividend date is May 28, 2010. CFR is a Dividend Achiever and has paid a higher dividend for 16 consecutive years. The yield based on the new payout is 3.02%.

Duff & Phelps (DUF) is an independent financial advisory company operates worldwide in two segments, Financial Advisory and Investment Banking. April 29th the company raised its quarterly dividend by 20% to $0.06/share. The yield based on the new payout is 1.50%.

Frequency of dividends increases is one of the most important things to consider when adopting a dividend growth investment strategy. For a list of stocks with a long string of consecutive cash dividend increases, see this list.

Full Disclosure: Long MCD, AOD, CVX, O, PG, JNJ. See a list of all my income holdings here.

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Dividend Payout vs. Free Cash Flow Payout *

D4L — Wed, 14 Oct 2009 10:30:29 +0000

I am a firm believer in keeping things simple. However, you can simplify things to the point they no longer have value. In my opinion, a lot of the commonly used financial metrics can be very misleading unless you understand what is behind them. I would put EBIT, EBITDA and Dividend Payout in this category. As an investor in dividend stocks, I see Dividend Payout used a lot, so let’s take a closer look at it.

Dividend payout is expressed as a percentage and is calculated by dividing annual dividend per share by annual earnings per share (EPS). This tells the investor what percentage of earning the company is paying out as a dividend. At first blush this may seem to make a lot of sense, but it suffers from the following potential problems:

I. Earnings Does Not Equal Cash

As an accountant, I can tell you our profession in its pursuit of theoretical perfection has adulterated the financial statements to the point that it has become very difficult for non-accountants to understand what’s behind the numbers. Accounting pronouncements such as SFAS No. 143 “Accounting for Asset Retirement Obligations” (ARO) that requires a company to recognize expenses today for cash payments that may not occur for decades or even centuries widens the gap between earnings and cash. Applying “fair value” principles allowed under GAAP, financial institutions (and others) can mark to market debt on their books and create non-cash income or expense, depending on the direction of interest rates. Many point to mark to market accounting as one of the major contributors to the 2008 financial melt-down.

II. Quality of Earnings

Would you rather a company that you are invested in to increase its earnings by 1.) increasing sales and holding cost down or 2.) sell a fully depreciated plant. Obviously, you would rather have the former since it has the possibility of being duplicated over and over again. You can only sell a specific asset once. In addition to cash and non-cash earnings, a statement of earnings also contains operating and non-operating earnings.

A Better Dividend Payout Calculation

A dividend payout ratio is supposed to provide the investor with an indication of how much cash as a percent of earnings the company is paying its investors. As you can see from the above discussion, a payout ratio based on GAAP net earnings could potentially have a lot of noise in it and not provide a clear picture of the economic condition of the business.

What the investor is really wanting to know is what percentage of cash is the company paying as a percentage of cash generated from running the business. The irony here is that operating cash is readily available on the Statement Of Cash Flows in the Operating section. This section focuses on the cash generated by running the business. It excludes cash generated by selling pieces of the business – these are shown in the investing section. It also excludes cash generated from selling stock or issuing debt – these are shown in the financing section.

In calculating a payout ratio, I prefer Free Cash Flow over Operating Cash Flow. Free Cash Flow is Operating Cash Flow less normal capital expenditures (normally the first line in the investing section). For a business to remain viable, it must replace capital assets when they wear out.

The formula for Free Cash Flow Payout is simply Annual Dividend Per Share divided by Free Cash Flow Per Share. I like to see a percentage of 70% or less. The 70% is somewhat higher than many people look for with a traditional payout ratio. I am comfortable with the higher number since we are talking about real cash generated from running the business vs. accounting earnings that may or may not be there. So how do the two ratios compare?

Needless to say, the variances are all over the place. In many companies I looked at the traditional dividend payout ratio was within 10 percentage points higher than a free cash flow payout. This means the GAAP earnings was lower than the calculated Free Cash Flow. Here are some example of this situation:

Chubb Corp (CB) – Traditional: 28% – FCF Payout: 21% – Analysis
Clorox Company (CLX) – Traditional: 50% – FCF Payout: 50%
Emerson Electric Co. (EMR) – Traditional: 53% – FCF Payout: 45% – Analysis
Family Dollar Stores Inc. (FDO) – Traditional: 25% – FCF Payout: 22%
Hormel Foods Corp. (HRL) – Traditional: 34% – FCF Payout: 33%
International Business Machines (IBM) – Traditional: 23% – FCF Payout: 18%
3M Co. (MMM) – Traditional: 50% – FCF Payout: 45% – Analysis
Microsoft Corp. (MSFT) – Traditional: 32% – FCF Payout: 29%
SYSCO Corporation (SYY) – Traditional: 52% – FCF Payout: 48% – Analysis
United Technologies Corp. (UTX) – Traditional: 35% – FCF Payout: 30% – Analysis

Sometime the gap is much larger. This could have resulted from significant non-cash charges on the income statement. Companies with large gaps include:

Aflac Incorporated (AFL) – Traditional: 44% – FCF Payout: 10% – Analysis
CenturyLink Inc. (CTL) – Traditional: 87% – FCF Payout: 46%
Diebold Inc (DBD) – Traditional: 74% – FCF Payout: 30%
Illinois ToolWorks Inc. (ITW) – Traditional: 76% – FCF Payout: 31% – Analysis
Leggett & Platt Inc. (LEG) – Traditional: 262% – FCF Payout: 34% – Analysis
Nucor Corporation (NUE) – Traditional: 88% – FCF Payout: 29% – Analysis
Pitney Bowes Inc. (PBI) – Traditional: 73% – FCF Payout: 38%
PPG Inds Inc (PPG) – Traditional: 158% – FCF Payout: 48%
RLI Corp (RLI) – Traditional: 158% – FCF Payout: 48% – Analysis
RPM International Inc (RPM) – Traditional: 84% – FCF Payout: 49% – Analysis
AT&T Inc. (T) – Traditional: 81% – FCF Payout: 49%

Sometimes the gap is not only large, but goes the other way. This is potentially the most dangerous since focusing on the traditional dividend payout may lead you to believe the dividend is covered better than it actually is. Examples of this situation would include:

Air Products and Chemicals Inc. (APD) – Traditional: 56% – FCF Payout: 172%
Franklin Resources Inc. (BEN) – Traditional: 23% – FCF Payout: 48%
BP Plc (BP) – Traditional: 50% – FCF Payout: 114% – Analysis
Lowe’s Companies, Inc. (LOW) – Traditional: 27% – FCF Payout: 57% – Analysis
Exxon Mobil Corp (XOM) – Traditional: 27% – FCF Payout: 54%

Although Free Cash Flow Payout is a better payout ratio than the traditional dividend ratio, the investor should look at both and understand the differences. Taking an expense for impairing goodwill is much different than recognizing an expense for losing a lawsuit. The former will not directly involve cash out the door, but the latter will if the company loses on appeal.

Full Disclosure: Long CLX, EMR, MMM, SYY, UTX, AFL, CTL, ITW, NUE, BP. See a list of all my income holdings here.

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Three Dividend Stocks With A Perfect Risk Score *

D4L — Tue, 06 Oct 2009 10:30:12 +0000

A good system continues to improve itself. I maintain an extensive database with a minimum of 10 years of information on each of the 110+ stocks that I track. This data is gathered from various sources deemed reliable. Most data is generic and can be pulled from various sites. That is except some S&P risk and quality information (RQ).

Gauging the relative risk of one stock compared to another is important when deciding which stock to buy or how much to weight a stock within your portfolio. Recently, during a scheduled site maintenance event on my broker’s site, S&P reports were temporarily unavailable. This made me question if I really wanted to rely on propriety financial information that was not readily available from multiple sources. Ultimately, I decided it was not a good thing. To remedy this situation, the RQ portion of my risk calculation was modified as such:

For the Risk portion, I opted to focus on consecutive dividend increases. The logic here is the longer a company raises its divided, the more committed it is to dividend increases and is less likely to stop unless dire financial circumstances dictate it. Instead of relying on S&P’s Qualitative Risk Assessment (Low, Medium and High) to assign a risk rating, I will now use the following to assign the A, B or C risk rating:

A Risk Rating is assigned to companies that have increased their dividends for greater than 25 years.
B Risk Rating is assigned to companies that have increased their dividends for 15-25 years.
C Risk Rating is assigned to companies that have increased their dividends for less than 15 years.

As for the Quality portion, I decided on use the company’s financial quality by focusing on Free Cash Flow payout and Debt to Total Capital. Instead of using S&P’s Quality Ranking (A+, A, A, B+, B, B-, C, D and Not Ranked) to assign a quality rating, I will now use the following to assign the 1, 2 or 3 quality rating:

1 Quality Rating is assigned to companies if their Free Cash Flow Payout % is less than 60% and if their Debt to Total Capital is less than 45%.
2 Quality Rating is assigned to companies if the sum of their Free Cash Flow Payout % plus their Debt to Total Capital is less than 100%.
3 Quality Rating is assigned to companies if the sum of their Free Cash Flow Payout % plus their Debt to Total Capital is greater than 100%.

Making this change to the 110+ companies I track. Here is what I found:

Overall the new method produces lower risk scores.
The overall risk rating on my income portfolio went from 1.78 (medium) to 1.68 (medium).
High risk stocks went from 7 stocks to 4 stocks.
Medium risk stocks went from 77 stocks to 54 stocks.
Low risk stocks went from 27 stocks to 53 stocks.

Excellent, low risk stocks evaluate the same under both systems. For example, the following three companies had a perfect 1.00 score under both systems:

Johnson & Johnson (JNJ) – Analysis
Procter & Gamble Co. (PG) – Analysis
Wal Mart Stores Inc. (WMT) – Analysis

While 60 companies improved their position, 19 companies ratings slipped under the new system. Below are some of the more notable changes:

Pepsico Inc. (PEP) went from a 1.00 (low) to 1.25 (low) – Analysis
United Technologies Corp. (UTX) went from a 1.25 (low) to 1.50 (low) – Analysis
Exxon Mobil Corp. (XOM) went from 1.50 (low) to 1.75 (medium)
Colgate Palmolive Co. (CL) went from 1.50 (low) to 1.75 (medium)
International Business Machines (IBM) went from 1.75 (medium) to 2.00 (medium)

The RQ portion of the risk rating is 50% of the calculation. The remaining two pieces are Current Price vs. Calculated Price and Dividend Yield. These are unchanged and their part of the risk rating calculation is discussed in Refining Risk Measurement Of Dividend Stocks.

Full Disclosure: Long JNJ, PEP, PG, UTX, WMT. See a list of all my income holdings here.

(Photo: sean carpenter)

Nine Stocks Giving Shareholders A Raise In The Second Quarter *

D4L — Fri, 03 Jul 2009 10:30:39 +0000

In 1985 I graduated from college and took my first job as a staff accountant with a $21,000 annual salary. Now I am over the same department that I was hired into and entry level staff accountants start with a base salary of $56,500 per year. That equates to a 4.2% annual increase. Just as employees expect an annual raise, so do dividend investors.

Understanding the importance of increasing dividends, these big-name companies raised their dividends in the second quarter:

Cardinal Health (CAH) – Yield: 2.28% – Analysis
Clorox (CLX) – Yield: 3.53% – Analysis
Del Monte Foods (DLM) – Yield: 2.08%
IBM (IBM) – Yield: 2.10%
Johnson & Johnson (JNJ) – Yield: 3.43% – Analysis
PepsiCo (PEP) – Yield: 3.18% – Analysis
Target (TGT) – Yield: 1.76%

Just this last week these two companies rewarded their shareholders with increased cash dividends:

General Mills (GIS) is a major producer of packaged consumer food products, including Big G cereals and Betty Crocker desserts/baking mixes. On June 29th, the company announced a 9% increase to its dividend to $0.47/share. The dividend is payable August 3, 2009, to shareholders of record July 10, 2009. At the new rate, the stock is yielding 3.23%.

MFA Financial (MFA) is a real estate investment trust that invests in secured by pools of mortgages on single family residences. This week MFA increased it quarterly dividend by 13.6% to $0.25/share. The ex-dividend date is July 9, 2009 and the dividend will be paid on July 31, 2009 to stockholders of record on July 13, 2009. At the new rate, the stock is yielding 14.29%.

The first step to identify excellent income stocks is to look for those that increase their dividend each year. For stocks with a long string of consecutive dividend increases, see this list.

Full Disclosure: Long CLX, JNJ, PEP. See a list of all my income holdings here.

(Photo Credit)

distributes and markets private label food and pet products.

IBM Assumes Familiar Leadership Role *

D4L — Fri, 01 May 2009 10:30:26 +0000

IBM (IBM), a name once synonymous with blue-chip technology, faced a near-death experience in the early 1990′s when it misjudged the importance of PCs at a time when demand for mainframes was waning and corporate downsizing was in full swing. IBM has never been able to regain it technology bellwether crown from Microsoft (MSFT) and Intel (INTC), but it has taken steps to regain its leadership role.

Last Tuesday, IBM stood up and was counted as a leader. At a time when the ill-prepared and the fearful are cutting dividends and hoarding cash, IBM increased its quarterly dividend 10% to $0.55/share and announced a $3 billion share repurchase program. The company has increased its quarterly dividend by 175% percent since 2006 and this is the 14th consecutive increase. The dividend is payable June 10, 2009 to stockholders of record May 8, 2009. based on the new rate, IBM is currently yielding: 2.10%

Below are many other companies joining IBM as leaders andrewarding their shareholders with higher cash dividends:

Cullen/Frost Bankers (CFR) increased its qtr. dividend 2% to $0.43/share. Yield 3.54% (analysis)
Donegal Group (DGICA) raised its qtr. dividend to $0.112/share. Yield: 3.07%
Valmont Industries (VMI) ups its qtr. dividend 15.4% to $0.15/share, Yield: 0.95%
Bemis (BMS) boosts qtr dividend to $0.225/share. Yield: 3.72%
Costco Wholesale (COST) increased its qtr dividend to $0.18/share. Yield: 1.50%
BOK Financial (BOKF) raised its qtr. dividend 6.7% to $0.24/share. Yield: 2.48%
W.W. Grainger (GWW) ups its qtr. dividend 15% to $0.46/share. Yield: 2.22%
Talisman Energy (TLM) boosts its semi-annual dividend 12.5% to $0.1125/share. Yield: 1.47%
ExxonMobil (XOM) increased its qtr. dividend to $0.42/share. Yield: 2.45%
UGI Corporation (UGI) raised its qtr dividend 4% to $0.20/share. Yield: 3.35%
Safeway (SWY) ups qtr. dividend 21% to $0.10/share. Yield: 1.56%
Occidental (OXY) boosts qtr. dividend 3.1% to $0.33/share. Yield: 2.23%

Hopefully, this is just the beginning and in the coming weeks we will continue to see more dividend increases. For more companies with a long string of consecutive dividend increases, see this list.

Full Disclosure: No position in the aforementioned securities. See a list of all my income holdings here.

(Photo: Steve Woods)

Stock Analysis: International Business Machines Corp. (IBM) A Value Priced Stock *

D4L — Wed, 12 Nov 2008 11:30:00 +0000

Linked here is a PDF copy of my detailed analysis of International Business Machines Corp. (IBM). Below are some highlights from the above linked analysis:

Company Description: IBM, the world’s largest technology company, offers a diversified line of computer hardware equipment, application and system software, and related services.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

Avg. High Yield Price
20-Year DCF Price
Avg. P/E Price
Graham Number

IBM is trading at a discount to 1.) and 3.) above. If I exclude the high and low valuations and average the remaining two, IBM is trading at a 15.4% discount. IBM earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:

Rolling 4-yr Div. > 15%
Dividend Growth Rate
Years of Div. Growth
1-Yr. > 5-Yr Growth
Payout 15% of avg.

IBM earned one Star in this section for 3.) above. IBM has paid a cash dividend to shareholders every year since 1916 and has increased its dividend payments for 13 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:

NPV MMA Diff.
Years to >MMA

IBM earned no Stars in this section. The NPV MMA Diff. of the $6,328 is below the $7,500 minimum I look for in a stock that has increased dividends as long as IBM has. If IBM grows its dividend at 14.7% per year, it will take 10 years to equal the cumulative earnings from a MMA yielding an estimated 20-year average rate of 4.61%.

Other: IBM is a member of the S&P 500 and a member of the Broad Dividend Achievers™ Index. IBM should benefit from strong revenue growth in emerging markets, improved margins from cost cutting measures and profitability in mature markets. Risks include pricing pressure and managing a transition to new hardware products.

Conclusion: IBM earned one Star in the Fair Value section, earned one Star in the Dividend Analytical Data section and did not earn any Stars in the Dividend Income vs. MMA section for a net total of two Stars. This quantitatively ranks IBM as a 2 Star-Weak stock.

Using my D4L-PreScreen.xls model, I determined the share price would need to drop to $81.57 for IBM’s NPV MMA Differential to be around the $7,500 that I like to see. At that price the stock would yield 2.33%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the $7,500 NPV MMA Differential I’m looking for, the calculated rate is 15.3%. This dividend growth rate is only slightly above the 14.7% used in this analysis.

Since IBM is trading below my calculated fair value of $101.95, it could be considered as a value play. However, if I were interested purchasing IBM, I would wait for a price below $81.57.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I had no position in IBM (0.0% of my Income Portfolio) .

What are your thoughts on IBM?