Verizon (VZ) is one of the strongest dividend-growth firms among the U.S. telecoms. Why? Because over the long run, its future cash remaining after paying out expected future dividends is the best in the group. But why does one make such an assessment? Well, this analysis reveals which firms have the greatest potential to raise their dividends above our current dividend-growth forecasts (4% CAGR for Verizon). Isn't this great to know? At Valuentum, the Dividend Cushion provides this framework. Let's dig into the measure for Verizon.
Verizon's dividend yield is excellent, offering a 4.1% 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. So Verizon fits the bill thus far.
Derivation of the Dividend Cushion - $ mil
We think the safety of Verizon's dividend is good (please see our definitions at the bottom of this article). We measure the safety of the dividend in a unique but very straightforward fashion, via the forward-looking Valuentum Dividend Cushion™. The measure is a ratio that sums the existing cash a company has on hand (on its balance sheet) plus its expected future free cash flows (cash from operations less capital expenditures) over the next five years and divides that sum by future expected dividends paid over the same time period. Dividing the numerator by the denominator results in the score (see the values in the graph above).
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 Verizon, this score is 2.1, revealing that on its current path the firm should be able to cover its future dividends with net cash on hand and future free cash flow.
Derivation of Excess Cash Available for Future Dividend Increases Beyond Expectations - $ mil
The above assumes Verizon raises its dividend by 4% in each of the next four years. Even after those dividend increases, the firm would still have $34 billion in excess cash (at the end of our five-year forecast horizon). Relative to its dividend payments, the firm's cash flow from operations is huge (and its sizable debt balance does little to deteriorate from this excess cash remaining). The bigger the box in blue the better!
Now on to the potential growth of Verizon'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, which is not the case for Verizon. Probably to no surprise, we have Verizon rated as having good dividend growth potential.
And because capital preservation is also an important consideration, we assess the risk associated with the potential for capital loss (offering investors a complete picture). In Verizon's case, we currently think the shares are fairly valued, so the risk of capital loss is medium. If we thought the shares were undervalued, the risk of capital loss would be low. All things considered, Verizon stands out to us as one of the better income plays on the market today. And we think our 4% dividend growth expectations may even be conservative.