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"The ultimate result of shielding men from the effects of folly, is to fill the world with fools."

Herbert Spencer

In the learning to fish series a wealth of key ratios are provided and one of the plays is picked as our favourite play. We list several reasons for picking this play, and in doing so, hope to impart some knowledge to those who are new to the field of dividend investing. A lot of ratios will be used throughout this article, and it would be best for investors to get a handle on some of these ratios as they could prove to be very handy in separating the wheat from the chaff.

Net income- it should be generally trending upwards for the past 3-4 years. There are exceptions to this rule. For example, if the net income has dropped but if operating cash flow is more than enough to meet the dividend payments and the company has a long stellar dividend history, then some leeway can be provided. An example is Exelon Corp.

Total cash flow from operating activities- it also should be trending upwards for the past 3-4 years.

Payout ratio- it should generally be below 100%, but a ratio below 70% is optimal. Payout ratios are not that important when it comes to MLPs / REITs as they generally pay a majority of their cash flow as distributions; in the case of REITS by law they have to pay out 90% of their cash flow as dividends. Payout ratios are calculated by dividing the dividend/distribution rate by the net income per share, and this is why the payout ratio for MLPs and REITs is often higher than 100%. The more important ratio to focus on is the cash flow per unit. If one focuses on the cash flow per unit, one will see that in most cases, it exceeds the distribution/dividend declared per unit/share.

Current ratio- should be above 1

Interest coverage ratio-any value above 1.5 is okay, but we would aim for 2.5-3.00 as our starting range. The higher the number, the better

Dividend growth rate- it should be at 5% or higher. A high yield with a low dividend growth rate is not good in the long run, but neither is a low dividend yield with a high growth rate; one needs to find an equilibrium here.

Five year dividend average- we generally aim for stocks that have a yield of 4.5% or higher. There are exceptions to this rule. Some stocks appreciate very fast, so even though the yield might be low, one can more than make up the difference through capital gains. Some examples are Jarden Corporation Common Stock, Potash Corporation of Saskatchewan, Cerner Corporation, etc.

Sales- they should generally be trending upwards for the past 3-4 years.

Levered free cash flow- this is the icing on the cake. If a company meets most of the above requirements and also has a positive levered free cash flow, it can generally be viewed as a good long term buy. Two examples are Leggett & Platt (NYSE:LEG), Incorporated and Procter & Gamble Company (NYSE:PG).

An early warning signal that the company could be in trouble is when the total cash flow generated from operating expenses is not enough to meet the dividend payments. This information can be gleaned by looking at the cash flow statement. In the example below we used LEG and the data was obtained from yahoo finance.

The cash flow in this case was more than enough to easily cover all the dividend payments for all the above years; in this the time period was from 2008-2010. Many traders use other metrics and that is fine; we are just trying to provide a guideline. As you get a better handle of the ratios explained below, you can create your own list of criteria.

Enterprise value- is a combination of the market cap, debt, minority interests, preferred shares less total cash and cash equivalents. This provides a better picture because it is a more accurate representation of a company's value contrary to simply looking at the Market cap.

Long-term debt-to-equity ratio - is the total long term debt divided by the total equity. The amount of long-term debt a company carries on its balances sheet is very important for it indicates the amount of money a company owes that it doesn't expect to pay off in the next year. A balance sheet that illustrates that long term debt has been decreasing for a few years is a sign that the company is doing well. When debt levels fall and cash levels increase, the balance sheet is said to be improving and vice versa. If a company has too much debt on its books, it could end up being overwhelmed with interest payments and risk having too little working capital, which could lead to bankruptcy in the worst case scenario.

Operating cash flow -is generally a better metric than earnings per share because a company can show positive net earnings and still not be able to properly service its debt; the cash flow is what pays the bills.

The payout ratio -tells us what portion of the profit is being returned to investors. A pay out ratio over 100% indicates that the company is paying out more money to shareholders, then they are making; this situation cannot last forever. In general, if the company has a high operating cash flow and access to capital markets, they can keep this going on for a while. As companies usually only pay the portion of the debt that is coming due and not the whole debt, this technique/trick can technically be employed to maintain the dividend for sometime. If the payout ratio continues to increase, the situation warrants close monitoring as this cannot last forever. If your tolerance for risk is a low, look for similar companies with the same or higher yields, but with lower payout ratios. Individuals searching for other ideas might find this article to be of interest.

Current Ratio -is obtained by dividing the current assets by current liabilities. This ratio allows you to see if the company can pay its current debts without potentially jeopardizing their future earnings. Ideally the company should have a ratio of 1 or higher.

Price to sales ratio is calculated by dividing the company's share price by its revenue per share. Generally, the smaller the ratio (less than 1.0) the better the investment, since the investor is paying less for each unit of sales. However, there are exceptions as a company with a low price to sales ratio could be unprofitable. It is sometimes used to determine the relative valuation of a sector.

Interest coverage- is usually calculated by dividing the earnings before interest and taxes for a period of 1 year by the interest expenses for the same time period. This ratio informs you of a company's ability to make its interest payments on its outstanding debt. Lower interest coverage ratios indicate that there is a larger debt burden on the company and vice versa. For example if a company has an interest ratio of 11.8, this means that it covers interest expenses 11.8 times with operating profits.

Inventory turnover -is calculated by dividing sales by inventory. If a company generated $30 million in sales and had an average inventory of $6 million, the inventory turnover would be equal to 5. This value indicates that there are 5 inventory turnovers per year. This means that it takes roughly 2.4 months to sell the inventory. A low inventory turnover is a sign of inefficiency and vice versa.

Price to tangible book - obtained by dividing share price by tangible book value per share. The ratio gives investors some idea of whether they are paying too much for what would be left over if the company were to declare bankruptcy immediately. In general, stocks that trade at higher price to tangible book value could leave investors facing a great percentage per share loss than those that trade at lower ratios. The price to tangible book value is theoretically the lowest possible price the stock would trade to. Additional key metrics are addressed in this article.

We like Plains All American Pipelines (NYSE:PAA) for the following reasons:

  • It is positioning itself to continue delivering attractive results. In 2011, $1.9 billion was invested in expansion capital and acquisitions, and management plans to invest in excess of $2.5 billion in 2012 through its $850 million expansion program and $1.7 billion on pending acquisitions of BP's Canadian NGL business.
  • Management has stated that they are planning on increasing distributions by 8-9% in 2012
  • It has a strong levered free cash flow of $1. 3B
  • It has a good five year dividend average of 7%
  • A good quarterly revenue growth rate of 22%
  • It has a very good free cash flow yield of 14.6%
  • It has very strong earnings per share growth rate of 106%
  • Net income has been increasing for the past 3 years; in 2009 it stood at $580 million and in 2011 it came in at $994 million.
  • Cash flow per share surged from $5.81 in 2009 to $8.50 in 2011.
  • Annual EPS before NRI has increased from $2.89 in 2007 to $5.24 in 2011.
  • Sales have jumped in the past 3 years, from $18 billion in 2009 to $34 billion 2011.
  • Operating income moved from $778 million in 2009 to $1.29 billion in 2011.
  • A very strong quarterly earnings growth rate of 92%
  • A decent five year dividend growth rate of 6%
  • It has consecutively increased its dividend for 12 years. The last increase was from 99.5 cents to $1.02.
  • It has a strong 3 year total return of 162%
  • Even though the payout ratio is not important as it's an MLP, it is well below 100. The current figure is 76%
  • It has average current ratio of 1, a weak quick ratio of 0.7, but it has a good interest coverage ratio of 5.7-- which more than makes up for this shortfall.
  • It ended the year with a strong balance sheet, with over $3.5 billion in committed liquidity and $26 million in cash and cash equivalents.
  • Adjusted net income and adjusted EBITDA for the 4th quarter were $322 and $471 million respectively, as compared to the 4th quarter 2010 results of $187 million and $322 million.
  • $100K invested for 10 years would have grown to $590K.

Company : Plains All American Pipeline

Levered Free Cash Flow = 1.38B

Basic Key ratios

  1. Percentage Held by Insiders = 1
  2. Market Cap ($mil) = 12410
  3. Number of Institutional Sellers 12 Weeks = 2

Growth

  1. Net Income ($mil) 12/2011 = 994
  2. Net Income ($mil) 12/2010 = 514
  3. Net Income ($mil) 12/2009 = 580
  4. 12mo Net Income this Q/ 12month Net Income 4Q's ago = 91.29
  5. Q Net Income this Q/ same qtr yr ago = 95.78
  1. EBITDA ($mil) 12/2011 = N/A
  2. EBITDA ($mil) 12/2010 = N/A
  3. EBITDA ($mil) 12/2009 = 1046
  4. Annual Net Income this Yr/ Net Income last Yr = 93.39
  5. Cash Flow ($/share) 12/2011 = 8.5
  6. Cash Flow ($/share) 12/2010 = 6.22
  7. Cash Flow ($/share) 12/2009 = 5.81
  1. Sales ($mil) 12/2011 = 34275
  2. Sales ($mil) 12/2010 = 25893
  3. Sales ($mil) 12/2009 = 18520

Dividend history

  1. Div Yield = 5.10
  2. Div Yield 5 Yr Average = 7.00%
  3. Annual Dividend 12/2011 = 3.91
  4. Annual Dividend 12/2010 = 3.76
  5. Forward Yield = 4.94
  6. Dividend 5yr Growth = 5.82%

Dividend sustainability

  1. Payout Ratio 09/2011 = 0.76
  2. Payout Ratio 06/2011 = 0.86
  3. Payout Ratio 5 Yr Average 09/2011 = 1.15
  4. Change in Payout Ratio = -0.38

Performance

  1. Percentage change Price 52 Wks Relative to S&P 500 = 22.22
  2. Standard Deviation Target Price Estimate = 5.28
  3. Average EPS Surprise Last 4 Qtr = 23.88
  4. EPS percentage Change F2/F1 = 9.02
  5. EPS Growth Q(1)/Q(-3) = -166.67
  6. 5 Year Historical EPS Growth 09/2011 = 6.69
  7. ROE 5 Yr Average 09/2011 = 13.73
  8. Return on Investment 09/2011 = 9.84
  9. Return on Investment 06/2011 = 8.9
  10. Debt/Total Cap 5 Yr Average 09/2011 = 47.1
  1. Current Ratio 09/2011 = 1.00
  2. Current Ratio 06/2011 = 1.02
  3. Current Ratio 5 Yr Average = 1
  4. Quick Ratio = 0.75
  5. Interest Coverage 09/2011 = 10.7
  6. Interest Coverage 06/2011 = 5.74

Valuation

  1. Book Value Qtr ($/share) 12/2011 = N/A
  2. Book Value Qtr ($/share) 09/2011 = 39.99
  3. Book Value Qtr ($/share) 06/2011 = 36.72
  4. Annual EPS before NRI 12/2007 = 2.89
  5. Annual EPS before NRI 12/2008 = 2.96
  6. Annual EPS before NRI 12/2009 = 3.14
  7. Annual EPS before NRI 12/2010 = 3.04
  8. Annual EPS before NRI 12/2011 = 5.24
  1. Price/ Book = 2.08
  2. Price/ Cash Flow = 9.77
  3. Price/ Sales = 0.36
  4. Q1 Std Dev/ Consensus = 0.1
  5. R-squared EPS Growth 12/2011 = N/A
  6. R-squared EPS Growth 09/2011 = 0.3

Notes: It would fall under the great- excellent category.

Hormel Foods Corp. (NYSE: HRL)

Industry : Food

Levered Free Cash Flow : 393.43M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $343 million
  3. Net Income 2010 = $396 million
  4. Net Income 2011 = $474 million
  1. EBITDA 12/2011 = $866 million
  2. EBITDA 12/2010 = $777 million
  3. EBITDA 12/2009 = $683 million
  4. Net income Reported Quarterly = $371 million
  1. Total cash flow from operating activities
  2. 2009 = $558.77 million
  3. 2010 = $485.54 million
  4. 2011 = $490.48 million
  1. Cash Flow 12/2011 = 2.26 $/share
  2. Cash Flow 12/2010 = 2.01 $/share
  3. Cash Flow 12/2009 = 1.75 $/share
  1. Annual EPS before NRI 12/2011 = 1.74
  2. Annual EPS before NRI 12/2010 = 1.51
  3. Annual EPS before NRI 12/2009 = 1.27
  4. Annual EPS before NRI 12/2008 = 1.04
  5. Annual EPS before NRI 12/2007 = 1.07

Performance

  1. ROE = 16.95%
  2. Return on Assets = 10.61%
  3. Quarterly Earnings Growth = -13.7%
  4. Quarterly Revenue Growth = 6.1%
  1. Total return last 3 years = 105.32%
  2. Total return last 5 years = 65.98%
  1. Key Ratios
  2. Price to Sales = 0.95
  3. Price to Book = 2.77
  4. Price to Tangible Book = 3.83
  5. Price to Cash Flow = 12.72
  6. Price to Free Cash Flow = 34
  1. Current Ratio 03/2012 = 2.79
  2. Current Ratio 12/2011 = 2.79
  3. Current Ratio 09/2011 = 2.57
  4. Current Ratio 5 Year Average = 2.21
  5. Quick Ratio = 1.43
  6. Cash Ratio = 0.81
  7. Interest Coverage 03/2012 = 61.53
  8. Interest Coverage 12/2011 = 61.53
  9. Interest Coverage 09/2011 = 55.82

Dividend sustainability

  1. Payout Ratio 12/2011 = 0.36
  2. Payout Ratio 09/2011 = 0.29
  3. Payout Ratio 06/2011 = 0.29
  4. Payout Ratio 5 Year Average 12/2011 = 0.31
  5. Change in Payout Ratio = 0.05

Dividend history

  1. Dividend yield 5 year average = 1.9%
  2. Dividend growth rate 3 year average = 12.83%
  3. Dividend growth rate 5 year average = 13.44%
  4. Consecutive dividend increases = 45 years
  5. Paying dividends since = 1928
  6. Total return last 3 years = 97.21%
  7. Total return last 5 years = 67.1%

Notes: It would fall under the category of good-great.

Company : Banco Santander, S.A. Sponsored (STD)

Basic Key ratios

  1. Percentage Held by Insiders = 9.48
  2. Market Cap ($mil) = 74212

Growth

  1. Net Income ($mil) 12/2011 = 7050
  2. Net Income ($mil) 12/2010 = 12086
  3. Net Income ($mil) 12/2009 = 13126
  4. 12months Net Income this Quarterly/ 12months Net Income 4Q's ago = -28.33
  5. Quarterly Net Income this Quarterly/ same Quarter year ago = -97.62
  1. EBITDA ($mil) 12/2010 = 39499
  2. EBITDA ($mil) 12/2009 = 33418
  3. Net Income Reported Quarterly ($mil) = 62
  4. Annual Net Income this Yr/ Net Income last Yr = -41.67
  5. Cash Flow ($/share) 12/2010 = 1.61
  6. Cash Flow ($/share) 12/2009 = 1.83
  7. Sales ($mil) 12/2010 = 100002
  8. Sales ($mil) 12/2009 = 106700
  1. Annual EPS before NRI 12/2007 = 1.95
  2. Annual EPS before NRI 12/2009 = 1.49
  3. Annual EPS before NRI 12/2010 = 1.25
  4. Annual EPS before NRI 12/2011 = 1.06

Dividend history

  1. Dividend Yield = 8.25
  2. Annual Dividend 12/2011 = 0.69
  3. Annual Dividend 12/2010 = 0.64
  4. Forward Yield = 8.25
  1. Dividend sustainability
  2. Payout Ratio 06/2011 = 0.55
  3. Payout Ratio 5 Year Average 06/2011 = 0.49
  4. Change in Payout Ratio = 0.06

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -34.92
  2. Next 3-5 Year Estimate EPS Growth rate = 12.4
  3. EPS Growth Quarterly (1)/Q(-3) = 145.46
  1. ROE 5 Year Average 06/2011 = 16.33
  2. Return on Investment 06/2011 = 3.37
  3. Debt/Total Cap 5 Year Average 06/2011 = 57.46
  1. Current Ratio 5 Year Average = 2.33
  2. Quick Ratio = 3.47
  3. Cash Ratio = 0.99
  4. Interest Coverage Quarterly = 1.40

Valuation

  1. Book Value Quarterly = 13.13
  2. Price/ Book = 0.63
  3. Price/ Cash Flow = 5.16

Notes: It would fall under the category of "average"

Kinross Gold Corp. (NYSE: KGC)

Industry : Precious Metals

Levered Free Cash Flow : -504.27M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $310 million
  3. Net Income 2010 = $772 million
  4. Net Income 2011 = $-2013 million
  1. EBITDA 12/2011 = $-925 million
  2. EBITDA 12/2010 = $1678 million
  3. EBITDA 12/2009 = $1019 million
  4. Net income Reported Quarterly = $405 million
  1. Total cash flow from operating activities
  2. 2008 = $443.6 million
  3. 2009 = $785.6 million
  4. 2010 = $968.4 million
  1. Cash Flow 12/2011 = 1.27 $/share
  2. Cash Flow 12/2010 = 0.87 $/share
  3. Cash Flow 12/2009 = 1.08 $/share
  1. Annual EPS before NRI 12/2011 = 0.77
  2. Annual EPS before NRI 12/2010 = 0.56
  3. Annual EPS before NRI 12/2009 = 0.44
  4. Annual EPS before NRI 12/2008 = 0.4
  5. Annual EPS before NRI 12/2007 = 0.59

Performance

  1. ROE = 6.1%
  2. Return on Assets = 4.95%
  3. Quarterly Revenue Growth = 3.1%
  4. Total return last 3 years = -35.62%
  5. Total return last 5 years = -20.05%
  1. Key Ratios
  2. Price to Sales = 2.86
  3. Price to Book = 0.9
  4. Price to Tangible Book = 1.29
  5. Price to Cash Flow = 7.78
  6. Price to Free Cash Flow = 9.6
  1. Current Ratio 09/2011 = 3.92
  2. Current Ratio 5 Year Average = 2.69
  3. Quick Ratio = 2.69
  4. Cash Ratio = 2.3
  5. Interest Coverage =23.30

Dividend history and sustainability

  1. Payout Ratio 09/2011 = 0.16
  2. Payout Ratio 06/2011 = 0.16
  3. Payout Ratio 5 Year Average 09/2011 = 0.16
  4. Payout Ratio 5 Year Average 06/2011 = 0.15
  5. Dividend yield 1.6%
  6. Dividend growth rate 3 year average = 17.5%
  7. Consecutive dividend increases = 3 years
  8. Paying dividends since = 2008

Notes: It would fall under the category of good- excellent.

Golden Star Resources Ltd. (AMEX: GSS)

Industry: Precious Metals

Levered Free Cash Flow: 1.55M

Growth

  1. Net income for the past three years
  2. Net Income 2009 = $-11 million
  3. Net Income 2010 = $-11 million
  4. Net Income 2011 = $-2 million
  1. EBITDA 12/2011 = $90 million
  2. EBITDA 12/2010 = $100 million
  3. EBITDA 12/2009 = $95 million
  4. Net income Reported Quarterly = $405 million
  1. Total cash flow from operating activities
  2. 2009 = $96.94 million
  3. 2010 = $96.62 million
  4. 2011 = $23.65 million
  1. Cash Flow 12/2011 = 0.25 $/share
  2. Cash Flow 12/2010 = 0.36 $/share
  3. Cash Flow 12/2009 = 0.5 $/share
  1. Annual EPS before NRI 12/2011 = -0.04
  2. Annual EPS before NRI 12/2010 = -0.03
  3. Annual EPS before NRI 12/2009 = 0.07
  4. Annual EPS before NRI 12/2008 = -0.18
  5. Annual EPS before NRI 12/2007 = -0.06

Performance

  1. ROE = 1.9%
  2. Return on Assets = 1.15%
  3. Quarterly Revenue Growth = 12.7%
  1. Key Ratios
  2. Price to Sales = 0.94
  3. Price to Book = 1.01
  4. Price to Tangible Book = 1.02
  5. Price to Cash Flow = 6.9
  6. Price to Free Cash Flow = 18.7
  1. Current Ratio 09/2011 = 0.86
  2. Current Ratio 5 Year Average = 1.95
  3. Quick Ratio = 0.53
  4. Cash Ratio = 0.49
  5. Interest Coverage 09/2011 = 3.94
  1. Total return last 3 years = 30.53%
  2. Total return last 5 years = -55.81%

Notes: It would fall under the category of "average-good".

EPS, EPS surprise, broker recommendations, and price and consensus charts sourced from zacks.com. Earning's estimates and growth rate charts sourced from dailyfinance.com. Free cash flow yield, income from cont operations, and revenue growth sourced from Ycharts.com.

Source: 5 Growth Plays To Consider: 2 Great, 1 Good And 2 Mediocre

Additional disclosure: This list of stocks is meant to serve as a starting point. Please do not treat this as a buying list. It is imperative that you do your due diligence and then determine if any of the above plays meet with your risk tolerance levels. The Latin maxim caveat emptor applies-let the buyer beware.