**Johnson & Johnson** (NYSE:JNJ) recently announced a 6.1% dividend increase in April. Given the company's solid EPS growth since 2011 (17% CAGR), many investors wonder whether the dividend growth can be improved in near future. In this article, I will provide readers some perspectives on the company's future cash flow and dividend trends.

I have performed free cash flow projections to gauge JNJ's capacity for dividend growth. My analysis started with consensus sales estimates which predict the top line to grow by 6.8% CAGR from $74.9B in 2014 to $81.8B in 2016. The company's operating cash flow margin trended quite steadily in the past 3 years with an average of 23.1%. Hence, I assumed the margin to remain flat at its 3-year average through 2016. It is noted that consensus estimates expect 200 bps EBITDA margin expansion from 2013 to 2016, meaning that my operating cash flow margin assumption could be somewhat conservative if JNJ can maintain a stable EBITDA to operating cash flow conservation level. For capital expenditure, I assumed the spending to rise gradually and reach $4.0B by 2016. Based on those conservative assumptions, free cash flow was projected to grow by 7.6% CAGR from $13.6B in 2014 to $15.7B in 2016 (see chart below).

As JNJ is expected to pay out a fiscal annual dividend of $2.76 per share in 2014, total dividend spending in the year would be about $7.8B based on my average share count estimate (discussed later). This would mean that free cash flow dividend payout ratio will rise from 53% in 2013 to 57% in 2014, which is still an acceptable level. Given my projected free cash flow CAGR of 7.6%, JNJ can grow its dividend spending at a similar rate (I used 7.5% here) in 2015 and 2016 such that the free cash flow payout trend would remain steady at around 57%. In this case, JNJ would have about $5.78B-$6.8B excess free cash flow in each year that can be deployed for share buybacks (see chart above).

For share repurchase, I assumed that JNJ will spend 80% of the excess free cash flow and the other 20% will be used for other corporate purposes. However, JNJ had quite significant equity issuance in the past 3 years which resulted in higher average share count despite the company's continued share buybacks. To be conservative, I assumed the share count to remain flat through 2016 even with my assumption of $4.7B-$5.4B share repurchase in each year to account for any additional equity issuance down the road. As such, dividend per share was projected to grow by 7.5% CAGR from $2.76 in 2014 to $3.19 in 2016. Compared with consensus EPS estimates, my forecasts imply that earnings dividend payout ratio will trend steadily at around 47% over the forecast period (see chart below).

As both the free cash flow and earnings dividend payout ratios are projected to be flat and the company has a consensus long-term EPS growth estimate of 7.13%, I believe my dividend per share growth forecast is within a sustainable range.

The following chart shows a quarterly breakdown of my annual dividend per share forecasts. As shown below, I expect an 8.0% dividend hike in Q2 2015 and a 7.4% increase in Q2 2016, both of which are better than the most recent 6.1% increase. In this scenario, dividend yield on cost will reach 3.1% by Q2 2016.

Based on current annualized (forward basis) dividend of $2.80 per share and 9% cost of equity, Gordon Growth Dividend Discount Model suggests that the current share price of ~$105 has priced in a dividend growth rate in between 6.0% and 6.5% (see chart below). Therefore, from a dividend income perspective, I recommend adding JNJ shares as the company has capacity to drive higher dividend growth and the current share valuation has not reflected that potential.

*All charts are created by the author, and historical data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.*

**Disclosure: **The author is long JNJ. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.