History has revealed that the best-performing stocks during the previous decades have been those that shelled out ever-increasing cash to shareholders in the form of dividends. Unfortunately for the individual investor, most dividend analysis that we've seen out there is backward-looking - meaning it rests on what the company has done in the past: how long it has raised its dividend, etc.
Although analyzing historical trends is important, we think assessing what may happen in the future is even more important. That is why we created a forward-looking assessment of dividend safety through our innovative, predictive dividend-cut indicator, the Valuentum Dividend Cushion™. We use our future forecasts for free cash flow and expected dividends and consider the company's net cash position to make sure that each company is able to pay out such dividend obligations to you -- long into the future. In this article, let's evaluate the dividend of Danaher (DHR).
First of all, Danaher's dividend yield is well below average, barely offering a payout at all. We prefer yields above 3% and don't include firms with yields below 2% in our dividend portfolio.
This may come as no surprise, but we think the safety of Danaher's dividend is EXCELLENT (please see our definitions at the bottom of this article). Frankly, we're not sure what the board is looking at, and we'd like to see some activism to push for more shareholder-friendly policies. 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. 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 is a better way to determine whether a firm has the capacity to continue paying dividends 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 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 Danaher, this score is 24.7, offering both a very large "cushion" and revealing excess capacity for future dividend growth. The magnitude of the Dividend Cushion score reveals Danaher's capacity to raise its dividend significantly. The beauty of the Dividend Cushion is that it can be compared apples-to-apples across companies. For example, Wal-Mart (WMT) scores a 1.5 on this measure. We use the dividend cushion as a key decision component in choosing companies for addition to the portfolio of our Dividend Growth Newsletter.
Now on to the potential growth of Danaher's dividend. As we mentioned above, the larger the "cushion" the larger capacity a company has to raise the dividend. However, such dividend growth analysis is not complete until after considering management's willingness to increase the dividend. Therefore, 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 Danaher.
In the image above (the matrix), one can see that Danaher has a very, very strong dividend--the cross section of its EXCELLENT safety and EXCELLENT future potential growth scores. And because capital preservation is also an important consideration for all investors, we assess the risk associated with the potential for capital loss. In Danaher's case, we think the shares are fairly valued, so the risk of capital loss is MEDIUM. If we thought Danaher was undervalued, we'd consider the risk to be LOW.
All things considered, we like the potential growth and safety of Danaher's dividend, but the yield is a bit low to get us excited. We'd wait for a dividend increase or a pullback in the shares to consider it a nice income play at these levels. The board needs to take some action to get shareholders excited. The glossary below shows how we rate a company's dividend in each key area: