- The most important time horizon for dividend growth investors is the future.
- Do your best to avoid backward-looking analysis.
- We think Intel will be one of the best dividend growth stocks over the next few decades.
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. This makes a lot of sense, as the strongest dividend growers are often the strongest generators of increasing cash flow. Intel (NASDAQ:INTC) is one such gem. Let's evaluate its dividend growth prospects in this article.
But first, let's start with framing this analysis for readers. Most dividend assessments tend to be backward-looking -- meaning, the evaluation rests more on what the company has done in the past: how long it has raised its dividend, for example. Don't misunderstand. We think analyzing historical trends is important, but investors should understand that for a cash-rich, growing company to raise its dividend by a reasonable amount in each of the past 20, 30 or more years isn't much to write home about.
Imagine, for example, giving your grandson $1 for his age on each consecutive birthday. Though you'll effectively be raising his "dividend" each year, the payout isn't necessarily tied to your income stream, nor is it very taxing on your lifestyle (even if he lives to 100 years or older). In a similar manner, a dividend payment is not explicitly tied to a firm's earnings stream, nor is it very taxing on a firm to raise its dividend each year. For one, firms with substantial earnings don't have to pay a dividend, and companies can report declining earnings and still raise their dividend in the same earnings release.
Over the long haul, earnings growth will have to support dividend growth, but in instances where the payout ratio is low, earnings don't necessarily have to expand for the company to raise its dividend for years and years. A company can double its payout ratio by raising its dividend for 50 consecutive years, for example, but the payout ratio at the end of the period could still only be 50% of earnings at the beginning of the 50-year period. Fascinating, no?
With all of this said, it becomes obvious that assessing the future capacity of growth of the dividend is really what matters most for dividend growth investors. After all, dividend growth investors are investing for the next 5, 10, 20 years, not the past 5, 10, 20. And they want their dividends to increase by a material amount. This forward-looking perspective that assesses the potential magnitude of future dividend growth is all the difference in the world. That is why we created a forward-looking assessment of dividend growth through the innovative Valuentum Dividend Cushion methodology.
For those that may not be familiar with our boutique research firm, we generate a discounted cash-flow analysis for all firms in our coverage. We use these future forecasts of free cash flow (cash flow from operations less capital expenditures) and expected cash dividend payments, and consider the company's net cash position to evaluate just how much capacity a firm has to keep raising its dividends long into the future.
The Dividend Cushion is a forward-looking ratio (with a numerator and a denominator). It tells investors how many times future free cash flow (cash from operations less capital spending) will cover future dividend payments after considering the net cash on the balance sheet, which is also a key source of dividend strength. It is purely fundamentally-based, and driven from items taken directly off the financial statements.
Let's take a look at Intel's investment highlights and then its dividend report to see how all of the analysis comes together.
Intel's Investment Highlights
- Intel's business quality (an evaluation of our ValueCreation™ and ValueRisk™ ratings) ranks among the best of the firms in our coverage universe. The firm has been generating economic value for shareholders, with relatively stable operating results for the past few years, a combination we view very positively. The company has an Economic Castle (learn more about how castles differ from moats here).
- Intel designs and manufactures advanced integrated digital technology platforms, which are used in PCs (including Ultrabooks), servers, tablets, smartphones, automobiles, automated factory systems, and medical devices.
- Intel has an excellent combination of strong free cash flow generation and low financial leverage. We expect the firm's free cash flow margin to average about 17.3% in coming years. Total debt-to-EBITDA was 0.7 last year, while debt-to-book capitalization stood at 18.8%.
- Though many fear Intel will be left behind by the mobile revolution, we think those worries are overblown. Intel will spend billions on research and development in the coming years, and we expect the company will become a viable competitor in the mobile space.
- Earlier this month, the firm raised its outlook, and investors cheered. The stock has been roaring as of late, and we think there is still pricing upside on the basis of the high end of the fair value range (shown in image below).
Intel's Dividend Report
Intel's dividend yield is nice, offering a ~3% annual payout at current price levels. Since the time of the publishing of the dividend report below (just few weeks ago), shares of Intel have surged from ~$26 to nearly $31 per share at present. As a result, the strong price performance has pushed down its yield a bit (now ~3%, was ~3.5% in the report). Still, we're expecting robust dividend growth from the chip giant. For example, the bottom right of the table in the image below reveals our expectations for Intel's future pace of dividend expansion (~8%-10% per annum). Please have a look.
Image Source: Valuentum
Let's now dig into Intel's qualitative ratings for dividend safety, dividend growth potential, and risk of capital loss. The Dividend Cushion ratio not only informs our opinion of the safety of the dividend, but also of its capacity for future growth. The higher the Dividend Cushion score above 1, the more capacity a firm has for future dividend increases.
Dividend Safety / Cushion - GOOD / 1.8
We assess the safety of a firm's dividend by adding the company's net cash to our forecast of its free cash flows over the next five years. We then divide that sum by the total expected dividends over the next five years. This process results in our Dividend Cushion™ ratio. A Dividend Cushion™ above 1 indicates a firm can cover its future dividends with net cash on hand and future free cash flow, while a score below 1 signals trouble may be on the horizon. And by extension, the greater the score, the safer the dividend, as excess cash can be used to offset any unexpected earnings shortfall. Intel scores a 1.8 on our Dividend Cushion™, which is GOOD.
Dividend Growth Potential - GOOD
We judge the future potential growth of the dividend by evaluating the capacity for future increases, as measured by the Dividend Cushion™, and management's willingness to consistently raise the dividend, as measured by the firm's dividend track record. Intel registers an GOOD rating on our scale, and we think the firm's annual dividend will be $1.27 per share within the next several years (by the end of fiscal 2018). This forecast is driven by our expectations of the dividend to expand at an ~8%-10% compound annual growth rate.
We assign the actual dividend growth rates to firms on the basis of their qualitative Dividend Growth rating. For example, because Intel has EXCELLENT dividend growth potential, we think its dividend will grow at a rate of ~8%-10%, roughly in line with earnings growth. We evaluate recent growth rates and/or the dividend payout ratio to fine-tune the trajectory of the forecasts. For those interested in dividend growth forecasts of other companies, we have dividend growth forecasts for every company in our 1,000+ firm coverage universe. The scale we use is shown below.
Dividend Growth Potential Scale
Excellent: 8% or higher
Very Poor: 0%-2%
Risk of Capital Loss - MEDIUM
We assess the risk of capital loss based on our analysis of a firm's intrinsic value at this point in time. If the stock is undervalued (based on our DCF process), we think the risk of failing to recoup one's original capital investment (ex dividends) is relatively LOW. If the stock is fairly valued (it falls within our fair value estimate range), we think the likelihood of losing capital (ex dividends) is MEDIUM. If the stock is trading above our estimate of its intrinsic value, we think the likelihood of losing at least a portion of one's original investment (ex dividends) is HIGH. Intel registers a score of MEDIUM on our scale (its shares are trading within our estimate of its fair value range). Though we generally prefer firms that are underpriced or have a LOW risk of capital loss, in this market environment, very few dividend growth firms are in this situation.
Wrapping It Up
Intel's Valuentum Dividend Cushion score is among the best in our coverage universe, after considering the size of its annual dividend yield. The company is benefiting from PC demand stabilization, and is now making a splash in mobile with its core M line of processors. We hold the company in the Dividend Growth portfolio, and we think the firm's dividend growth potential is as strong as ever.
The following provides the definitions of the terms you may have read in the dividend report (image) above. Thank you for reading!
Additional disclosure: INTC is included in Valuentum's newsletter portfolios.