Here are four important directional metrics that I look for when updating my stock database...
1. 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 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 DebtWhen 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 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.
4. Rising Free Cash Flow/ShareUltimately, 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 DirectionCombining 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:
Franklin Resources Inc. (BEN) is one of the world's largest asset managers, serving retail, institutional and high-net-worth clients.
Debt to Total Capital | 2010: 22%, TTM: 15%
Free Cash Flow/Share | 2010: $2.24, TTM: $2.79
Raytheon Company (RTN), the world's fifth largest military contractor, specializes in making high-tech missiles, advanced radar systems and sensors, defense electronics, and missile-defense systems.
Debt to Total Capital | 2010: 37%, TTM: 34%
Free Cash Flow/Share | 2010: $4.13, TTM: $8.13
Cincinnati Financial Corp. (CINF) is an insurance holding company that primarily markets property and casualty coverage. It also conducts life insurance and asset management operations.
Debt to Total Capital | 2010: 14%, TTM: 11%
Free Cash Flow/Share | 2010: $3.15, TTM: $6.75
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 | 2010: 67%, TTM: 43%
Free Cash Flow/Share | 2010: $2.54, TTM: $7.79
Wal-Mart Stores, Inc. (WMT) is the largest retailer in the world, operating a chain of over 10,000 discount department stores, wholesale clubs, supermarkets and supercenters.
Debt to Total Capital | 2010: 42%, TTM: 28%
Free Cash Flow/Share | 2010: $2.98, TTM: $6.79
Westwood Holdings Inc. (WHG) provides investment advisory services to a wide range of institutional clients, and also provides trust and custodial services.
Debt to Total Capital | 2010: 0%, TTM: 0%
Free Cash Flow/Share | 2010: $2.68, TTM: $5.00
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 BEN, RTN, CINF, CBRL, WMT, WHG. See a list of all my Dividend Growth Portfolio holdings here.
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Tags: BEN, RTN, CINF, CBRL, WMT, WHG,