Dividends can be a very important component of an investor's total return over time. Not only can they add to the return that an investor gets through share price appreciation, but they can also provide protection to the downside of an investment, as well as serve as an indication from management that they are confident in the company's prospects.
Today, let's explore the dividends of Emerson Electric (NYSE:EMR), a company that is known throughout the investing world as a consistent dividend payer. Let's see how their dividends measure up today in terms of strength, sustainability, and potential growth.
The dividend yield is usually the first thing that investors look at when evaluating a company's dividend, and for good reason. The dividend yield represents the amount of your investment that you will get back over the next 12 months. Many investors compare the dividend yields of certain stocks to the interest rates that they might receive from alternative investments like bonds and certificates of deposit. Some investors even use the dividend yield to determine how cheap or expensive a stock might be, based on where the current dividend yield is versus where it has been historically.
The dividend yield of Emerson Electric is currently at 2.6%, which is fairly respectable in absolute terms. Over the last five years, the company's dividend yield has ranged between 2.2% and 4.2%. However, those dividend yields of around 4% occurred during the depths of the financial crisis back in 2009, which most can agree was an extraordinary time. After the financial crisis, the yield has ranged between 2.2% and 3.4%.
While a good dividend yield might be nice, it doesn't always tell the whole story about where the dividend is going. Stocks can have high dividend yields for several different reasons, including depressed stock prices brought on by poor fundamentals. These are the kinds of stocks that you want to avoid.
In addition to finding a stock with a good yield, you want to make sure that the company has a history of increasing its dividends, to help you protect your income stream from inflation. It also helps that dividend growth is often a sign from management that the company's prospects are good.
Table 1: Dividend Growth Rates From Emerson Electric
While Emerson Electric has an impressive record of consecutive annual dividend increases for the last 57 years, the most recent increases have been small with the exception of the 16% increase seen back in 2011. However, even the most recent dividend growth still beats out inflation, which currently sits at just above 1%.
Free Cash Flow Payout Ratio
In addition to a good dividend yield and strong dividend growth, you want to make sure that the company is generating enough free cash flow in order to keep those dividends going. To do this, I calculate what I call the free cash flow payout ratio, which is simply the percentage of free cash flow that is eaten up by the dividend over a 12-month period. Lower free cash flow payout ratios are better, as they leave more room for future dividend increases and other value-creating activities.
Free cash flow is defined as the company's cash flow from operations minus its capital expenditures over a given time period.
Table 2: Free Cash Flow Payout Ratios Of Emerson Electric
Over the last 12 months, Emerson Electric spent 40% of its free cash flows on dividends. This figure is inline with what the company did over the last three full fiscal years. These are very healthy free cash flow payout ratios that show that the dividend is not in any sort of danger at this point in time.
Interest Coverage Ratio
You also want to make sure that the company's debt will not have an adverse effect on the company's dividend going forward. Money spent on interest payments is money that's not being used for dividends and other value-creating activities. To determine the effect that the company's debt might have, I calculate the interest coverage ratio, which is the company's earnings before interest and taxes (EBIT) divided by the company's interest expense over the last 12 months. If the ratio comes in at below 2, then the company might be having trouble servicing its debt, which does not bode well for its dividend.
Fortunately, this is not a problem at all for Emerson Electric, as its pretax earnings covered its interest obligations almost 16 times over the last 12 months. Going forward, debt should not have any effect at all on the company's dividends.
Earnings Per Share Growth Forecasts
The main driver of dividend growth is free cash flow growth, which is in turn driven by earnings growth. While dividend growth might be achieved in the near term by expanding the free cash flow payout ratio, earnings growth will ultimately determine how long a company can continue increasing its dividend.
To get an idea as to what to expect over the next couple of years in this area, it can help to look at the analyst estimates for that time period. During fiscal 2014, analysts expect Emerson Electric to earn $3.79 per share, which amounts to a 7.1% increase over the $3.54 that was posted in fiscal 2013. In 2015, analysts expect earnings per share growth of 11.1%. Please note that these figures are non-GAAP figures.
Emerson Electric currently sports a reasonably attractive dividend yield that is well-supported by its free cash flow. Recently, the company has been conservative when it comes to dividend growth, as can be seen from the last two low single-digit increases. With a free cash flow payout ratio of just 40% and high single-digit to low double-digit earnings per share growth on the horizon, Emerson Electric certainly has the ability to increase its dividend at a higher rate.
It should be mentioned that at least over the last three fiscal years, the company spent just as much money on buybacks as it did on dividends, while taking on little debt in the process. If Emerson chooses to slow down its buybacks, we could see this company increase its dividend by at least a high single-digit rate if not a low double-digit rate.
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.