Abbott's (ABT) split into two companies has made life a little confusing for the individual investor. However, we've updated our work on the new Abbott's dividend coverage, and we were generally pleased with what we found. Let's dig into our dividend growth forecasts for the new Abbott, which is now independent of AbbVie (ABBV).
Abbott's Investment Considerations
Abbott's Return on Invested Capital
For starters, the safety of Abbott's dividend is excellent (please see our definitions at the bottom of this article). We measure the safety of the dividend in a unique but very straightforward fashion. As many know, earnings can fluctuate in any given year, so using the payout ratio in any given year has some limitations. Plus, companies can often encounter unforeseen charges, which makes earnings an even less-than-predictable measure of the safety of the dividend in any given year. We know that companies won't cut the dividend just because earnings have declined or they had a restructuring charge that put them in the red for the quarter (year). As such, we think that assessing the cash flows of a business allows us to determine whether it has the capacity to continue paying these cash outlays well into the future.
That has led us to develop the forward-looking Valuentum Dividend Cushion™. The measure is a ratio that sums the existing cash a company has on hand plus its expected future free cash flows over the next five years and divides that sum by future expected dividends over the same time period. Basically, if the score is above 1, the company has the capacity to pay out its expected future dividends. As income investors, however, we'd like to see a score much larger than 1 for a couple of reasons: 1) the higher the ratio, the more "cushion" the company has against unexpected earnings shortfalls, and 2) the higher the ratio, the greater capacity a dividend-payer has in boosting the dividend in the future.
For Abbott, the Valuentum Dividend Cushion score is 4.4, revealing that on its current path the firm can cover its future dividends with net cash on hand and future free cash flow over 4 times. We also use our dividend cushion as a key decision component in choosing companies for addition to the portfolio of our Dividend Growth Newsletter (please see our links on the left sidebar for more information).
Now on to the potential growth of Abbott's dividend. As we mentioned above, we think the larger the "cushion" the larger capacity it has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. To do so, we evaluate the company's historical dividend track record. If there have been no dividend cuts in 10 years, the company has a nice growth rate, and a nice dividend cushion, its future potential dividend growth would be excellent. Though our historical information shows a reduction in the dividend, this was mainly a result of the spin-off of AbbVie (and not a cut by any stretch of the imagination). However, we still rate the firm's dividend growth potential as good (and not excellent), as we'd like to get a better feel as to whether management will deliver on its capital allocation plans successfully.
All things considered, the new Abbott's dividend yield is below average, offering just a 1.6% annual payout at recent price levels. We prefer yields above 3% and don't include firms with yields below 2% in our dividend growth portfolio. Plus, we currently think the shares are fairly valued. But while the new Abbott doesn't quite meet our criteria, its dividend growth potential and safety look sound.