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. Most dividend analysis that we've seen out there is backward-looking -- meaning it rests on what the firm has done in the past. 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 firm'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 Applied Materials (NASDAQ:AMAT):
(Click image to expand)
Click to enlargeFirst of all, Applied Materials's dividend yield is about 2.6%, so we view the name as a nice potential income generator. We think the safety of its dividend is EXCELLENT on our scale. 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 in any given year. 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 Applied Materials, this score is 4.8, offering both a nice "cushion" and revealing excess capacity for future dividend growth. The beauty of the Dividend Cushion is that it can be compared apples-to-apples across companies. For example, Wal-Mart (WMT) scores a 3 on this measure.
Now on to growth. 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 and the company has a nice growth rate, its future potential dividend growth is EXCELLENT, which is the case for Applied Materials.
However, we don't just stop there. By employing a matrix, one can see above that Applied Materials has a nice dividend--the cross section of its EXCELLENT safety and EXCELLENT 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 Applied Materials's case, we think the shares are fairly valued, so the risk of capital loss is MEDIUM. If we thought Applied Materials was undervalued, we'd consider the risk to be LOW.
All things considered, the growth potential and safety of Applied Materials 's dividend are attractive, and the size of its yield makes the firm worth considering as a potential income play. We would consider it for inclusion in our Dividend Growth Newsletter if the firm's shares fell to the lower end of our fair value range.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.