In this article, let's evaluate the dividend growth potential of General Motors (NYSE:GM). Given its recent, rocky history, investors may be wary of this newly reinstated dividend. Dividend analysis tends to be backward-looking, and in GM's case, the past isn't all that rosy. Although analyzing historical trends is important, we think assessing what may happen in the future is even more important. That is why we use 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 determine if a company is able to pay out such dividend obligations to shareholders.
First of all, GM's newly reinstated dividend yield is in line with what dividend growth investors are looking for, offering a 3% annual payout at recent price levels. We weren't totally surprised by this level, given the comparable payout at automaker peer Ford (NYSE:F). Still, this is quite a hefty initiation.
Let's get started. We think the safety of GM's dividend is EXCELLENT. 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 (read hiccups in operations), which makes earnings an even less-than-predictable measure of the safety of the dividend. 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 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 GM, this score is 4.2, offering both a nice "cushion" and revealing excess capacity for future dividend growth. Still, we must remain cognizant of the company's pension obligations, which could weigh on cash flows in the future.
Now on to the potential growth of GM'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. As such, 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 unfortunately isn't the case for GM. GM's dividend track record has been spotty in recent years, as it cut and then eliminated its dividend. We rate GM's dividend growth potential as GOOD, instead of EXCELLENT because of its track record, which is to a large part driven by the structural characteristics of the auto industry:
The auto manufacturers industry is characterized by high fixed costs, substantial operating leverage, and intense competition. Vehicle sales are impacted by general economic conditions, which are largely out of the control of participants, and by the cost of credit and fuel. Excess capacity, price discounting and other marketing initiatives can pressure the top line, while rising raw material and labor costs can squeeze the bottom line. Changing consumer preferences in type, model and fuel-efficiency can cause abrupt shifts in market share. The structural characteristics of the group are very poor.
By employing a matrix (in the image above), one can see that GM's dividend is on solid ground, despite these structural concerns--the cross section of its EXCELLENT safety and GOOD future potential growth scores. 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 GM's case, we think the shares are fairly valued (but trading at the low end of the fair value range), so the risk of capital loss is MEDIUM. If we thought GM was undervalued, we'd consider the risk to be LOW. All things considered, General Motors has disappointed in the past, but its recently-reinstated dividend appears to be on solid ground.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: F is included in the Best Ideas Newsletter.