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We want to show you why Johnson & Johnson (NYSE:JNJ) is a dividend growth gem. We're going to get into the gory financial details and show how its excess cash flow (cushion) after paying out ever-growing dividend payments means that it can even raise its dividend above and beyond our future expectations of 8% annual expansion. Let's dig in.

Johnson & Johnson's Investment Considerations

Johnson & Johnson's Dividend

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Before moving on, please take a look at the front page of our dividend report on Johnson & Johnson (image above). In the bottom right of the image, you'll see that we're forecasting a compound annual dividend growth rate of 8% (through 2017) -- not bad! Plus, Johnson & Johnson's dividend yield is already above the average of S&P 500 companies (~2%), offering a 3%+ annual payout at current price levels. We prefer yields above 3% and don't include firms with yields below 2% in our dividend growth portfolio. So Johnson & Johnson fits the bill thus far.

The Safety of Johnson & Johnson's Dividend

Derivation of the Dividend Cushion Score for Johnson & Johnson - $ mil

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Source: Valuentum

We think the safety of Johnson & Johnson's dividend is good (please see our definitions at the bottom of this article). But how do we come to this conclusion? 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 net cash a company has on hand (on the balance sheet) plus its expected future free cash flows over the next five years and divides that sum (the numerator in the image above) by future expected dividends paid (the denominator in the image above) 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 Johnson & Johnson, this score is 2.2, revealing that on its current path the firm should easily cover its future dividends with net cash on hand and future free cash flow. And remember, we're already expecting annual dividend expansion of 8% during this time period.

Derivation of Excess Cash That Could Be Used to Raise the Dividend Above and Beyond Our Growth Expectations - $ mil

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Source: Valuentum

You'll see from above that Johnson & Johnson is a cash cow and that it even boasts a net cash position on the balance sheet. The sum of future dividends to be paid is large, but its excess cash cushion (the blue box) leaves a lot of wiggle room for future growth. We like firms that have a large 'blue box' -- a large Dividend Cushion.

The Growth Potential of Johnson & Johnson's Dividend

Now on to the potential growth of Johnson & Johnson'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 the case for Johnson & Johnson. The firm is a Dividend Aristocrat.

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 Johnson & Johnson'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, Johnson & Johnson's dividend track record has been very impressive, and the company is one of our very favorite dividend growth ideas. Its 'blue box' is one of the best in our coverage universe, even after our forecasted growth in the dividend.

Disclosure: JNJ is included in our Dividend Growth portfolio. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Why Johnson & Johnson Is A Dividend Growth Gem ... All The Financial Details