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.
In this article, let's evaluate the dividend of Baxter International (BAX).
First of all, Baxter International's dividend yield is about 2.4%, so we view the name as a nice potential income generator. We think the safety of its dividend is GOOD. 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 Baxter International, this score is 2.6, 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 1.4 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 Baxter International.
However, we don't just stop there. By employing a matrix, one can see above that Baxter International has a nice dividend--the cross section of its GOOD 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 Baxter International's case, we think the shares are fairly valued, so the risk of capital loss is MEDIUM. If we thought Baxter International was undervalued, we'd consider the risk to be LOW.
All things considered, we like the potential growth and safety of Baxter International's dividend, but the yield is a bit low to get us excited. We'd wait for a dividend increase or a pullback in the shares to consider it for inclusion in the portfolio of our Dividend Growth Newsletter.