The goal of dividend investing is to find and buy dividend growth stocks that will continue to raise their dividends. To pay and raise its dividend, a company must generate sufficient free cash flow. However, 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.
Prior to the 2008-2009 downturn, many companies took on enormous levels of debt, usually for one of these two reasons:
I. Fund An Acquisition
Debt has been relatively cheap for some time and easy to access. When the market is roaring and buyers stock is overpriced, sellers will demand significant levels of cash to close the deal. Often debt is used to raise the cash and the target company's free cash is expected to pay back the debt over time.
Analysts that follow companies have a target debt to total capital they are looking for. If they consider it is too low, management is encouraged to issue debt and use the proceeds to purchase their stock. (As an aside, before the 2008/2009 downturn, some issued debt and purchased their stock close to its high. Then when the economy turned down they had to raise operating cash by, you guessed it, issuing stock well below where they purchased it.)
Having low levels of debt provides companies with greater financial flexibility. To gauge how levered a company is, the metric I like to look at is debt to total capital. Debt includes both long-term and short-term debt and is readily available on the liabilities side of the balance sheet. Total capital is a combination of debt and shareholders equity. When you divide debt by total capital, a desirable rate is something less than 35%, but I will consider rates up to 50% on a short-term basis.
This week week, I screened my dividend growth stocks database for stocks with:
- Debt to total capital less than 35%
- Positive FCF Payout of 60% or lower
- Market Cap. greater than $2 billion
- Dividend growth of 4% or higher
- Dividend yield of 2.5% or higher
The results are presented below:
General Dynamics (GD) is the world's fourth largest military contractor and also one of the world's biggest makers of corporate jets. The company has paid a cash dividend to shareholders every year since 1979 and has increased its dividend payments for 22 consecutive years.
Yield: 2.6% | Growth: 9.39% | Debt/Cap: 24.94% | FCF Payout: 36.41%
Genuine Parts Co. (GPC) is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products. The company has paid a cash dividend to shareholders every year since 1948 and has increased its dividend payments for 57 consecutive years.
Yield: 2.7% | Growth: 6.15% | Debt/Cap: 22.92% | FCF Payout: 39.41%
Owens & Minor Inc. (OMI) is a leading domestic distributor of medical and surgical supplies to the acute care market, a health care supply chain management company, and a direct-to-consumer (DTC) supplier of testing and monitoring supplies for diabetes. The company has paid a cash dividend to shareholders every year since 1926 and has increased its dividend payments for 15 consecutive years.
Yield: 2.7% | Growth: 9.09% | Debt/Cap: 17.98% | FCF Payout: 26.65%
Microsoft (MSFT), the world's largest software company, develops PC software, including the Windows operating system and the Office application suite. The company has paid a cash dividend to shareholders every year since 2003 and has increased its dividend payments for 10 consecutive years.
Yield: 2.8% | Growth: 15.00% | Debt/Cap: 16.50% | FCF Payout: 31.60%
Erie Indemnity Co. (ERIE) is a management services company that provides sales, underwriting, and policy issuance services to the policyholders of Erie Insurance Exchange in the United States. The company has paid a cash dividend to shareholders every year since 1991 and has increased its dividend payments for 23 consecutive years.
Yield: 3.2% | Growth: 6.54% | Debt/Cap: 0.00% | FCF Payout: 20.07%
Maxim Integrated Products, Inc. (MXIM) designs, develops and manufactures linear and mixed-signal integrated circuits used mainly in signal processing applications. The company has paid a cash dividend to shareholders every year since 2002 and has increased its dividend payments for 13 consecutive years.
Yield: 3.6% | Growth: 4.71% | Debt/Cap: 23.63% | FCF Payout: 52.46%
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 230+ 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. The D4L-Data spreadsheet is a part of D4L-Premium Services and is updated each Saturday for subscribers.
Disclosure: Long GD, GPC, OMI, MSFT in my Dividend Growth Portfolio. See a list of all my dividend growth holdings here.