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In the learning to fish series, we provide investors with suggested guidelines for choosing a potential candidate and one candidate is selected as our play of choice. We provide reasons for this choice and in doing so hope to impart some understanding 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 useful to the selection process. Some of the more important key ratios are listed below.

We generally base our choice on the following factors.

Net income - It should be generally trending upwards for the past 3-4 years.

Cash flow per share - It should be trending upwards for the past three years.

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

Current ratio - Should be above 1.

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

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) and Procter & Gamble (NYSE:PG).

The following criteria apply only to dividend paying stocks and not to growth stocks that might not pay out dividends:

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.

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. And there are exceptions to this rule, some stocks appreciate rather rapidly and so a low dividend could be offset by the capital gains.

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. One example is Jarden (NYSE:JAH).

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. This is readily available at Yahoo Finance. 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. Investors looking for other ideas might find this article to be of interest - A Naked Put Strategy For Linn Energy.

Reasons to be bullish on PNC Financial Services group Inc (NYSE:PNC):

  • A strong free cash flow of $5.3 billion
  • Year over year growth of 3.5% and 7.8% 2012 and 2013 respectively
  • Five year cash flow per share average of $6.11
  • A strong 52-week relative strength score of 70
  • Quarterly revenue growth 7.8%
  • Operating margin of 31.4%
  • Profit margin of 22.19%
  • Net income increased from $2.4 billion to $3.05 billion in 2011
  • EBITDA increased from $5.4 billion in 2009 to $6.03 billion in 2011
  • Cash flow per share increased from $6.43 in 2009 to $8.52 in 2011
  • Annual EPS before NRI increased from $5.05 in 2007 to $6.18 in 2011
  • Strong institutional support; percentage held by institutions is 80%
  • A good five year sales growth rate of 12.15%
  • Long-term debt to equity ratio of 0.64
  • A low payout ratio of 23%
  • A projected 3-5 year EPS growth rate of 5.4%
  • A very strong free cash flow yield of 17.4%
  • A good interest coverage ratio of 4.2
  • $100K invested for 10 years would have grown to $195K; if the dividends were reinvested the rate of return would be far higher

Company: PNC Financial Services Inc

Basic Key ratios

  1. Percentage Held by Insiders = 0.28
  2. Number of Institutional Sellers 12 Weeks = 3
  3. Relative Strength 52 weeks = 70
  4. Dividend 5-year Growth = -25.53
  5. Cash Flow 5 -year Average = 6.11
  6. Dividend Yield 5-Year Average = 2.61

Growth

  1. Net Income ($mil) 12/2011 = 3056
  2. Net Income ($mil) 12/2010 = 3412
  3. Net Income ($mil) 12/2009 = 2447
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = -15.81
  5. Quarterly Net Income this Quarterly/same Quarter year ago = -3.36
  1. EBITDA ($mil) 12/2011 = 6035
  2. EBITDA ($mil) 12/2010 = 6077
  3. EBITDA ($mil) 12/2009 = 5465
  4. Annual Net Income this Yr/ Net Income last Yr = -10.43
  5. Cash Flow ($/share) 12/2011 = 8.52
  6. Cash Flow ($/share) 12/2010 = 8.12
  7. Cash Flow ($/share) 12/2009 = 6.43
  1. Sales ($mil) 12/2011 = 15820
  2. Sales ($mil) 12/2010 = 17096
  3. Sales ($mil) 12/2009 = 16988
  1. Annual EPS before NRI 12/2007 = 5.05
  2. Annual EPS before NRI 12/2008 = 3.68
  3. Annual EPS before NRI 12/2009 = 3.45
  4. Annual EPS before NRI 12/2010 = 6.07
  5. Annual EPS before NRI 12/2011 = 6.18

Dividend history

  1. Dividend Yield = 2.40
  2. Dividend Yield 5 Year Average 12/2011 = 2.61
  3. Dividend Yield 5 Year Average 09/2011 = 2.61
  4. Annual Dividend 12/2011 = 1.15
  5. Annual Dividend 12/2010 = 0.4
  6. Forward Yield = 2.51
  7. Dividend 5 year Growth 12/2011 = -25.53

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.23
  2. Payout Ratio 5 Year Average 12/2011 = 0.33
  3. Payout Ratio 5 Year Average 09/2011 = 0.33
  4. Payout Ratio 5 Year Average 06/2011 = 0.33
  5. Change in Payout Ratio = -0.1

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = 0.84
  2. Next 3-5 Year Estimate EPS Growth rate = 5.39
  3. EPS Growth Quarterly(1)/Q(-3) = -106.37
  4. ROE 5 Year Average 12/2011 = 9.69
  5. Return on Investment 06/2011 = 4.89
  6. Debt/Total Cap 5 Year Average 12/2011 = 52.46
  1. Current Ratio 06/2011 = 0.86
  2. Current Ratio 5 Year Average = 0.86
  3. Quick Ratio = 0.84
  4. Cash Ratio = 0.05
  5. Interest Coverage Quarterly = 4.27

Valuation

  1. Book Value Quarterly = 67.68
  2. Price/ Book = 1.02
  3. Price/ Cash Flow = 11.60
  4. Price/ Sales = 2.18
  5. Price/free cash flow = 6.00

Company: MasterCard Inc (NYSE:MA)

Basic Key ratios

Percentage Held by Insiders = 0.15

Number of Institutional Sellers 12 Weeks = 3

Growth

  1. Net Income ($mil) 12/2011 = 1906
  2. Net Income ($mil) 12/2010 = 1846
  3. Net Income ($mil) 12/2009 = 1463
  1. EBITDA ($mil) 12/2011 = 2970
  2. EBITDA ($mil) 12/2010 = 2992
  3. EBITDA ($mil) 12/2009 = 2560
  1. Cash Flow ($/share) 12/2011 = 20.49
  2. Cash Flow ($/share) 12/2010 = 15.5
  3. Cash Flow ($/share) 12/2009 = 13.24
  1. Sales ($mil) 12/2011 = 6714
  2. Sales ($mil) 12/2010 = 5539
  3. Sales ($mil) 12/2009 = 5099
  1. Annual EPS before NRI 12/2007 = 5.7
  2. Annual EPS before NRI 12/2008 = 9.04
  3. Annual EPS before NRI 12/2009 = 11.38
  4. Annual EPS before NRI 12/2010 = 14.05
  5. Annual EPS before NRI 12/2011 = 18.7

Dividend history

  1. Dividend Yield = 0.3
  2. Dividend Yield 5 Year Average =0.3
  3. Forward Yield = 0.3
  4. Dividend 5 year Growth =32%

Dividend sustainability

  1. Payout Ratio = 0.04

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = 60.35
  2. Next 3-5 Year Estimate EPS Growth rate = 15.57
  3. EPS Growth Quarterly(1)/Q(-3) = 106.06
  4. ROE 5 Year Average 12/2011 = 42.51
  5. Return on Investment 06/2011 = 42.61
  6. Debt/Total Cap 5 Year Average 06/2011 = 2.08
  1. Current Ratio 06/2011 = 1.84
  2. Current Ratio 5 Year Average = 1.85
  3. Quick Ratio = 1.84
  4. Cash Ratio = 1.64
  5. Interest Coverage Quarterly = N/A

Company: American Express Co (NYSE:AXP)

Basic Key ratios

  1. Percentage Held by Insiders = 1.48
  2. Number of Institutional Sellers 12 Weeks = 3

Growth

  1. Net Income ($mil) 12/2011 = 4935
  2. Net Income ($mil) 12/2010 = 4057
  3. Net Income ($mil) 12/2009 = 2130
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = 13.81
  5. Quarterly Net Income this Quarterly/same Quarter year ago = 6.79
  1. EBITDA ($mil) 12/2011 = 10194
  2. EBITDA ($mil) 12/2010 = 9304
  3. EBITDA ($mil) 12/2009 = 6118
  4. Annual Net Income this Yr/ Net Income last Yr = 21.64
  5. Cash Flow ($/share) 12/2011 = 4.99
  6. Cash Flow ($/share) 12/2010 = 4.15
  7. Cash Flow ($/share) 12/2009 = 2.42
  1. Sales ($mil) 12/2011 = 28850
  2. Sales ($mil) 12/2010 = 27819
  3. Sales ($mil) 12/2009 = 24523
  1. Annual EPS before NRI 12/2007 = 3.43
  2. Annual EPS before NRI 12/2008 = 2.42
  3. Annual EPS before NRI 12/2009 = 1.54
  4. Annual EPS before NRI 12/2010 = 3.41
  5. Annual EPS before NRI 12/2011 = 4.12

Dividend history

  1. Dividend Yield = 1.3
  2. Dividend Yield 5 Year Average 12/2011 = 1.9
  3. Dividend Yield 5 Year Average 09/2011 = 1.9
  4. Annual Dividend 12/2011 = 0.72
  5. Annual Dividend 12/2010 = 0.72
  6. Forward Yield = 1.33
  7. Dividend 5 year Growth 12/2011 = 2.84

Dividend sustainability

  1. Payout Ratio 09/2011 = 0.17
  2. Payout Ratio 06/2011 = 0.18
  3. Payout Ratio 5 Year Average 12/2011 = 0.28
  4. Payout Ratio 5 Year Average 09/2011 = 0.28
  5. Payout Ratio 5 Year Average 06/2011 = 0.28
  6. Change in Payout Ratio = -0.11

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = 18.9
  2. Next 3-5 Year Estimate EPS Growth rate = 11.57
  3. EPS Growth Quarterly(1)/Q(-3) = -110.31
  4. 5 Year History EPS Growth 12/2011 = 6.42
  5. 5 Year History EPS Growth 09/2011 = 6.42
  6. ROE 5 Year Average 12/2011 = 25.99
  7. ROE 5 Year Average 09/2011 = 25.99
  8. ROE 5 Year Average 06/2011 = 26.52
  9. Return on Investment 12/2011 = 6.25
  10. Return on Investment 09/2011 = 6.25
  11. Return on Investment 06/2011 = 6.12
  12. Debt/Total Cap 5 Year Average 12/2011 = 80.33
  13. Debt/Total Cap 5 Year Average 09/2011 = 80.33
  14. Debt/Total Cap 5 Year Average 06/2011 = 80.66
  1. Current Ratio 12/2011 = 1.86
  2. Current Ratio 09/2011 = 1.86
  3. Current Ratio 06/2011 = 1.21
  4. Current Ratio 5 Year Average = 1.71
  5. Quick Ratio = 1.21
  6. Cash Ratio = 0.44
  7. Interest Coverage Quarterly = 4.09

Company: Washington REIT (NYSE:WRE)

Levered Free Cash Flow = 53.2 Million

Basic Key ratios

  1. Percentage Held by Insiders = 0.73
  2. Number of Institutional Sellers 12 Weeks = 5
  3. Relative Strength 52 weeks = 57
  4. Dividend 5-year Growth = 0.53
  5. Cash Flow 5 -year Average = 2.01
  6. Dividend Yield 5-Year Average = 5.91

Growth

  1. Net Income ($mil) 12/2011 = 105
  2. Net Income ($mil) 12/2010 = 37
  3. Net Income ($mil) 12/2009 = 41
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = 180.24
  5. Quarterly Net Income this Quarterly/same Quarter year ago = 189.77
  1. EBITDA ($mil) 12/2011 = 173
  2. EBITDA ($mil) 12/2010 = 174
  3. EBITDA ($mil) 12/2009 = 187
  4. Annual Net Income this Yr/ Net Income last Yr = 180.28
  5. Cash Flow ($/share) 12/2011 = 1.62
  6. Cash Flow ($/share) 12/2010 = 1.86
  7. Cash Flow ($/share) 12/2009 = 2.09
  1. Sales ($mil) 12/2011 = 290
  2. Sales ($mil) 12/2010 = 298
  3. Sales ($mil) 12/2009 = 307
  1. Annual EPS before NRI 12/2007 = 2.31
  2. Annual EPS before NRI 12/2008 = 2.12
  3. Annual EPS before NRI 12/2009 = 2.14
  4. Annual EPS before NRI 12/2010 = 1.96
  5. Annual EPS before NRI 12/2011 = 1.95

Dividend history

  1. Dividend Yield = 5.8
  2. Dividend Yield 5 Year Average 12/2011 = 5.91
  3. Dividend Yield 5 Year Average 09/2011 = 5.91
  4. Annual Dividend 12/2011 = 1.74
  5. Forward Yield = 6.06
  6. Dividend 5 year Growth 12/2011 = 0.53

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.92
  2. Payout Ratio 5 Year Average 12/2011 = 0.81
  3. Change in Payout Ratio = 0.11

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -8.09
  2. EPS Growth Quarterly(1)/Q(-3) = -104.44
  3. ROE 5 Year Average 12/2011 = 2.52
  4. Return on Investment 06/2011 = -4.89
  5. Debt/Total Cap 5 Year Average 06/2011 = 18.31
  1. Current Ratio 06/2011 = 0.08
  2. Current Ratio 5 Year Average = 0.11
  3. Quick Ratio = 0.08
  4. Cash Ratio = 0.03
  5. Interest Coverage Quarterly = N/A

Company: Bristol-Myers (NYSE:BMY)

Levered Free Cash Flow = $5.16B

Basic Key ratios

  1. Percentage Held by Insiders = 0.64
  2. Market Cap ($mil) = 56819

Growth

  1. Net Income ($mil) 12/2011 = 3709
  2. Net Income ($mil) 12/2010 = 3102
  3. Net Income ($mil) 12/2009 = 10612
  4. 12months Net Income this Quarterly/12 months Net Income 4Q's ago = 19.57
  5. Quarterly Net Income this Quarterly/same Quarter year ago = 76.4
  1. EBITDA ($mil) 12/2011 = 7782
  2. EBITDA ($mil) 12/2010 = 6815
  3. EBITDA ($mil) 12/2009 = 6309
  4. Annual Net Income this Yr/ Net Income last Yr = 19.57
  5. Cash Flow ($/share) 12/2011 = 2.79
  6. Cash Flow ($/share) 12/2010 = 2.61
  7. Cash Flow ($/share) 12/2009 = 2.21
  1. Sales ($mil) 12/2011 = 21244
  2. Sales ($mil) 12/2010 = 19484
  3. Sales ($mil) 12/2009 = 18808
  1. Annual EPS before NRI 12/2007 = 1.38
  2. Annual EPS before NRI 12/2008 = 1.74
  3. Annual EPS before NRI 12/2009 = 1.85
  4. Annual EPS before NRI 12/2010 = 2.16
  5. Annual EPS before NRI 12/2011 = 2.28

Dividend history

  1. Dividend Yield = 4.10
  2. Dividend Yield 5 Year Average =4.61%
  3. Annual Dividend 12/2011 = 1.32
  4. Annual Dividend 12/2010 = 0.96
  5. Forward Yield = 4.04
  6. Dividend 5 year Growth = 0.41%

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.58
  2. Payout Ratio 5 Year Average 06/2011 = 0.7
  3. Change in Payout Ratio = -0.12

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = 20.21
  2. Next 3-5 Year Estimate EPS Growth rate = 1.67
  3. EPS Growth Quarterly(1)/Q(-3) = -112.77
  4. ROE 5 Year Average 06/2011 = 26.33
  5. Return on Investment 06/2011 = 18.29
  6. Debt/Total Cap 5 Year Average 06/2011 = 30.31
  1. Current Ratio 06/2011 = 1.97
  2. Current Ratio 5 Year Average = 1.9
  3. Quick Ratio = 1.79
  4. Cash Ratio = 1.31
  5. Interest Coverage = 49

Disclaimer

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.

Source: PNC Financial Services Our Play Of Choice Among 5 Interesting Candidates

Additional disclosure: EPS and EPS surprise charts obtained from zacks.com. A major portion of the historical data used in this article was obtained from zacks.com. Earnings and growth estimates sourced from dailyfinance.com