New income investors naturally focus on yield, but the highest yielding stocks aren't always the best investments. To find the very best dividend growth stocks an investor must identify companies that will not just sustain their dividends, but increase them every year. To find these jewels in the rough, there are two very important things the investor must look for.
First, dividends are paid in cash. Therefore, if a company is going to pay a dividend it must have cash available. If the company is going to consistently pay and grow its dividend, it must have a vibrant business model that generates a growing level of cash. Unfortunately, most businesses have a degree of variability in which earnings and cash don't grow in a smooth line.
Free Cash Flow Payout
How well a company can absorb these ups and downs is reflected in its free cash flow payout. Free cash flow payout is calculated as dividends divided by free cash flow (operating cash flows less normal capital replacements). Components of free cash flow are found on the Cash Flow Statement. Free cash flow tells you how much cash the company has left over after paying the normal operating expenses. This is the cash used to pay for acquisitions, debt obligations and dividends!
Debt To Total Capital
It is not enough to just generate the cash, it has to be available for dividend payments. Many companies generate significant free cash flow, but often that cash is already spoken for in the form of debt obligations. To gauge the relative amount of debt a company is carrying, I look at a debt to total capital metric.
For both free cash flow and debt to total capital, the lower the number the safer the dividend. However, if free cash flow payout is too low, you might question the company's commitment to its dividend.
This week, I screened my dividend growth stocks database for 4 or 5-Star companies with a debt to total capital less than 40, free cash payout less than 60% and with a yield above 3.0%. The results are presented below:
Automatic Data Processing Inc. (NASDAQ:ADP), one of the world's largest independent computing services companies, provides a broad range of data processing services.
Yield: 2.9% | Debt/Capital: 0.3% | FCF Payout: 56.4%
Emerson Electric Co. (NYSE:EMR) designs and supplies product technology, and delivers engineering services and solutions to a wide range of industrial, commercial, and consumer markets around the world.
Yield: 3.0% | Debt/Capital: 35.4% | FCF Payout: 50.5%
Genuine Parts Co. (NYSE:GPC) is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products.
Yield: 3.0% | Debt/Capital: 14.6% | FCF Payout: 44.6%
The Procter & Gamble Company (NYSE:PG) is a leading consumer products company markets household and personal care products in more than 180 countries.
Yield: 3.3% | Debt/Capital: 32.9% | FCF Payout: 48.0%
Johnson & Johnson (NYSE:JNJ) is a leader in the pharmaceutical, medical device and consumer products industries.
Yield: 3.4% | Debt/Capital: 22.5% | FCF Payout: 45.3%
Microsoft (NASDAQ:MSFT), the world's largest software company, develops PC software, including the Windows operating system and the Office application suite.
Yield: 3.4% | Debt/Capital: 13.9% | FCF Payout: 26.4%
Cincinnati Financial Corp. (NASDAQ:CINF) is an insurance holding company that primarily markets property and casualty coverage. It also conducts life insurance and asset management operations.
Yield: 4.0% | Debt/Capital: 15.4% | FCF Payout: 52.4%
Intel Corporation (NASDAQ:INTC) is the world's largest manufacturer of microprocessors, the central processing units of PCs, and also produces other semiconductor products.
Yield: 4.3% | Debt/Capital: 12.7% | FCF Payout: 45.8%
ConocoPhillips Co. (NYSE:COP) is one of the largest independent oil and gas exploration and production (E&P) companies in the world. COP spun off its downstream assets in May 2012.
Yield: 4.4% | Debt/Capital: 35.7% | FCF Payout: 47.4%
As with past screens, the data presented above is in its raw form. Some of the the companies would be disqualified for poor dividend fundamentals. However some of the others may be worth additional due diligence.
My database, D4L-Data, is an Open Office spreadsheet containing more than 20 columns of information on the 220+ companies that I track. The data is sortable and has built-in buttons and macros to make it easy to use. Companies included in the list are those that have had a history of dividend growth.
Disclosure: Long ADP, EMR, GPC, PG, JNJ, MSFT, CINF, INTC, COP. See a list of all my dividend growth holdings here.