Growing EquityChanges 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.
Declining SharesMany 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 leery of a company that consistently grows its shares outstanding in the absence of major acquisitions.
Free Cash FlowFree cash flow focuses on cash generated by the business. It excludes asset sales and cash generated from financing, such as debt issuances and stock sales. To have cash available for dividends, a company must have cash left over after paying the operating expenses and normal capital expenditures. For this I looked for companies that had positive free cash flow for the last 10 years and a free cash flow payout less than 60%.
Debt To Total CapitalDividends that are paid out of free cash flow must compete for other needs of the business such as interest and debt payments. Lower debt and interest requirements make available more cash for dividend payments. Like shares outstanding, I am leery of a company that consistently issues debt in the absence of major acquisitions. For this metric, I looked for companies that have a debt to total capital of 45% or less.
Cash On The Balance SheetSome businesses are so good at what they do and have so few opportunities for reinvestment, they tend to build large cash balances. Companies such as this that also pay a cash dividend, provide an additional layer of comfort that the dividend is sustainable.
Stocks With Quality FinancialsAmounts in millions
United Technologies Corp. (UTX) | Yield: 2.9%
Equity: 2005 $16,991, 2010 21,385, 2015 30,525
Shares: 2005 1,014, 2010 923, 2015 893
FCF Payout: 54%
Debt to Total Capital: 43%
Cash on Balance Sheet: $5,477
AFLAC Incorporated (AFL) | Yield: 2.8%
Equity: 2005 $7,927, 2010 11,056, 2015 17,018
Shares: 2005 508, 2010 473, 2015 444
FCF Payout: 11%
Debt to Total Capital: 27%
Cash on Balance Sheet: $3,103
Microsoft Corporation (MSFT) | Yield: 3.1%
Equity: 2005 $40,104, 2010 57,083, 2015 80,083
Shares: 2005 10,531, 2010 8,593, 2015 8,254
FCF Payout: 51%
Debt to Total Capital: 31%
Cash on Balance Sheet: $96,526
Genuine Parts Company (GPC) | Yield: 3.1%
Equity: 2005 $2,694, 2010 2,794, 2015 3,244
Shares: 2005 175, 2010 159, 2015 154
FCF Payout: 49%
Debt to Total Capital: 21%
Cash on Balance Sheet: $223.8
Wal-Mart Stores, Inc. (WMT) | Yield: 3.1%
Equity: 2006 $53,171, 2011 68,542, 2016 76,574
Shares: 2006 4,188, 2011 3,670, 2016 3,240
FCF Payout: 43%
Debt to Total Capital: 40%
Cash on Balance Sheet: $7,759
A solid foundation is just the beginning. Selecting quality dividend stocks with sustainable dividends requires the investor to not only look back at the financials, but also look forward to determine in the business can continue to thrive going forward. To succeed as a dividend investor, you must find companies that can sustain and grow dividends by focusing on their ability to generate cash. You can fake earnings, but you can’t fake cash.
Full Disclosure: Long UTX, AFL, MSFT, GPC, WMT in my Dividend Growth Portfolio. See a list of all my dividend growth holdings here.
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