A photograph captures a moment in time. Seconds after the flash dims a tree could have fallen on the object of the photo or the sad looking man in the photo could have been told he just won a million dollars. In much the same way a dividend stock analysis is a snapshot in time, but the real question for the savvy dividend investor is, "Where is the stock headed?"
Here are four important directional metrics that I look for when updating my stock database.
1. Declining Shares
Many companies sell stock to raise cash. The important question is what is the company going to do with the cash? Is it for an acquisition or "general corporate purposes?" The latter is code for the business is not generating enough cash to stay afloat on its own. I am wary of a company that consistently has more shares outstanding in the current year when compared to the prior year. As I enter updates to my database, equal or lower shares outstanding is a sign of a healthy business.
2. Declining Debt
When companies need to raise cash and selling shares is not a good option, they often will issue debt. Once again, the important question is what is the company going to do with the cash? Like issuing shares, debt for a strategic acquisition is much more palatable than for "general corporate purposes." I am wary of a company that consistently has more debt outstanding than the year before. As I enter updates to my database, I make note of companies with a declining debt balance and see that as a sign of a healthy business.
3. Rising Equity
Changes in shareholder's equity are a result of earnings, dividends paid, Treasury stock purchased, stock options exercised and stock issued. If shares outstanding aren't increasing, and equity is rising then the business is generating sufficient earnings to cover dividends and share repurchases. Increasing the value of the company by running the business well is a sign of a healthy company.
4. Rising Free Cash Flow/Share
Ultimately, we want our investments to generate more free cash flow so they can pay us higher dividends. Free cash flow is an important metric in that it excludes cash generated from issuing stock or issuing debt or selling off parts of the business. Free cash flow is limited to only the cash generated from running the business.
Dividend Stocks Headed In The Right Direction
Combining the equity and debt metrics, I looked for companies with a declining debt to total capital ratio, and combining the free cash flow and shares outstanding metrics, I looked for a rising free cash flow per share. Below are several companies I noted that exhibited each of the above characteristics:
AFLAC Inc. (AFL) provides supplemental health and life insurance in Japan (80% of earnings) and the U.S. Products are marketed at work sites and help fill gaps in primary coverage.
Debt to Total Capital | 2008: 31%, TTM: 25%
Free Cash Flow/Share | 2008: $9.33, TTM: $21.81
Cracker Barrel Old Country Store (CBRL) develops and operates the Cracker Barrel Old Country Store restaurant and retail concept in the United States.
Debt to Total Capital | 2008: 89%, TTM: 45%
Free Cash Flow/Share | 2008: $1.58, TTM: $4.42
Erie Indemnity Co. (ERIE) is a management services company that provides sales, underwriting, and policy issuance services to the policyholders of Erie Insurance Exchange in the United States.
Debt to Total Capital | 2008: 0%, TTM: 0%
Free Cash Flow/Share | 2008: $4.09, TTM: $16.67
International Business Machines Corp. (IBM) global capabilities include information technology services, software, computer hardware equipment, fundamental research and related financing.
Debt to Total Capital | 2008: 72%, TTM: 64%
Free Cash Flow/Share | 2008: $10.85, TTM: $13.18
Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device and consumer products industries.
Debt to Total Capital | 2008: 22%, TTM: 18%
Free Cash Flow/Share | 2008: $4.20, TTM: $4.64
Kimberly-Clark Co. (KMB) is a global consumer products company producing tissue, personal care and health care products. Its brands include Huggies, Pull-Ups, Kotex, Depend, Kleenex and Scott.
Debt to Total Capital | 2008: 61%, TTM: 54%
Free Cash Flow/Share | 2008: $3.85, TTM: $5.42
3M Company (MMM) is a diversified global company provides enhanced product functionality in electronics, health care, industrial, consumer, office, telecommunications, safety & security and other markets via coatings, sealants, adhesives and other chemical additives.
Debt to Total Capital | 2008: 41%, TTM: 26%
Free Cash Flow/Share | 2008: $4.33, TTM: $6.09
Businesses can pay dividends with cash generated from many sources. They can generate cash by issuing shares, which dilutes our ownership. They can generate cash by issuing debt, which burdens the company with interest payments. Or, they can generate cash by running the business well, which neither dilutes the current shareholders' interest or burdens them with future cash payments. Which would you rather have?
Full Disclosure: Long AFL, JNJ, KMB, MMM in my Dividend Growth Portfolio. See a list of all my dividend growth holdings here.
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