We often ask investors if companies can pay out dividends with earnings (payout ratio). Almost all of them say yes. But in reality, earnings are but an accounting measure. Dividends are paid in cash, and cash-flow analysis is the absolute core of dividend investing. That is why we created a forward-looking assessment of dividend safety in our predictive dividend-cut indicator, the Dividend Cushion. In this article, let's evaluate the investment merits of Ford Motor Company (NYSE:F), as well as its dividend under this unique but yet very straightforward framework.
Ford Motor Company's (F) Investment Considerations
Ford Motor Company's (F) Dividend
Before moving on, please take a look at (select) the front page of our Dividend Report on Ford Motor Company (F) (the image above) and more specifically look at the future growth rates we assign to the company's dividend in the bottom right corner. Please note that we expect Ford Motor Company (F) to increase its dividend at a 5% compound annual growth rate in coming years (which is embedded in our forecasts and analysis).
Currently, Ford Motor Company's (F) dividend yield is above the average of S&P 500 companies (~2%), offering a 2.3% 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 Ford Motor Company (F) doesn't quite fit the bill thus far.
Is Ford Motor Company's (F) Dividend Safe Over the Long Haul?
Though this may come as a shock to some because we hold Ford Motor Company (F) in our Best Ideas portfolio (it is not a holding in our Dividend Growth portfolio, which focuses on companies that are poised to raise their dividends significantly), we think the safety of Ford Motor Company's (F) dividend is poor (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 Dividend Cushion™. The measure is a ratio that sums the existing 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 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 Ford Motor Company (F), this score is 1.1, revealing that on its current path, there's only but a very modest cushion to cover its future dividends with net cash on hand and future free cash flow. To receive a good rating on our system, we'd prefer a measure north of 1.25 (so think of it as a 25% margin of safety on the firm's cash flow stream relative to dividends).
What About the Growth of Ford Motor Company's (F) Dividend?
Now on to the potential growth of Ford Motor Company's (F) 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 Ford Motor Company (F). Though we are expecting a mid-single-growth rate in its dividend, we rate the firm as having very poor 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 Ford Motor Company's (F) case, we currently think the shares are undervalued, so the risk of capital loss is low. If we thought the shares were fairly valued, the risk of capital loss would be medium.
All things considered, Ford Motor Company's (F) dividend is back! However, its Dividend Cushion score suggests it may not be of the strongest variety.
Additional disclosure: Ford Motor Company (F) is included in our Best Ideas portfolio.