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Novice investors would do well to follow some of the suggested guidelines when it comes to looking for new investment ideas. These are not absolute rules; they are just suggestions and there are always exceptions to the rule. The goal is to try to satisfy as many of them as possible. In terms of stocks that pay dividends investors would do well not to obsess on the yield factor only. Unusually high yields are generally not associated with safe long-term investors, and they can sometimes be a sign that all is not well with the company. Some of the more important key ratios are listed below, but before we provide guidelines and details on some of the more important key ratios, we would like to start off by listing our play of choice.

Some reasons to be bullish on Citigroup Inc:

  • It has a very strong free cash flow rate of $64 billion.
  • Net income has increased from $-1.6 billion in 2009 to $11.06 billion in 2011.
  • EBITDA has increased from $12.7 billion in 2009 to $33.3 billion in 2011.
  • It has a 5 year average cash flow of $5.56 per share.
  • Annual EPS before NRI has increased from $-13.40 in 2009 to $3.66 in 2011.
  • Cash flow per share increased from $-1.77 in 2009 to $4.87 in 2011.
  • A low payout ratio of 10%.
  • A high beta of 2.03 which makes it a good candidate for covered writes or for selling naked puts if one is bullish on the stock.
  • Operating margins of 21.8%.
  • Year over year growth projected rates of 11.6 and 16.09% for 2012 and 2013 respectively.

Suggested Strategy for Citigroup

We would only consider purchasing this stock under the following circumstances. Wait for it to pull back to the $25 ranges where it has a fairly strong degree of support. We would then sell naked puts with strikes in the 23 ranges to ensure an even better entry. If the shares trade below 23 you will be assigned the stock, but your final price will be much lower due to the premium factor.

We generally base our choice on the following factors:

Net income - It should be generally trending upwards for the past 3 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 (LEG) and Procter & Gamble (PG).

The following criteria apply only to dividend paying stocks and not to growth stocks that might not payout 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 generally be above the official rate of inflation. 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 3.5% 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 (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.

Company: Citigroup Inc (C)

Free cash flow= $64B

Basic Key ratios

  1. Relative Strength 52 weeks = 37
  2. Cash Flow 5 -year Average = 5.56

Growth

  1. Net Income ($mil) 12/2011 = 11067
  2. Net Income ($mil) 12/2010 = 10602
  3. Net Income ($mil) 12/2009 = -1606
  1. EBITDA ($mil) 12/2011 = 33370
  2. EBITDA ($mil) 12/2010 = 32777
  3. EBITDA ($mil) 12/2009 = 12783
  4. Cash Flow ($/share) 12/2011 = 4.87
  5. Cash Flow ($/share) 12/2010 = 4.66
  6. Cash Flow ($/share) 12/2009 = -1.77
  1. Sales ($mil) 12/2011 = 78353
  2. Sales ($mil) 12/2010 = 86601
  3. Sales ($mil) 12/2009 = 91100
  1. Annual EPS before NRI 12/2009 = -13.4
  2. Annual EPS before NRI 12/2010 = 3.5
  3. Annual EPS before NRI 12/2011 = 3.66

Dividend history

  1. Dividend Yield = 0.10
  2. Dividend Yield 5 Year Average 12/2011 = 2.06

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.01
  2. Payout Ratio 5 Year Average 12/2011 = 0.8

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 8.25
  2. EPS Growth Quarterly(1)/Q(-3) = -111
  3. ROE 5 Year Average 12/2011 = -2.54
  1. Current Ratio 06/2011 = 1.07
  2. Current Ratio 5 Year Average = 1.09
  3. Quick Ratio = 1.07
  4. Cash Ratio = 0.58
  5. Interest Coverage = 1.60

Company: CenturyLink Inc (CTL)

Levered Free Cash Flow = $2.82B

Basic Key ratios

  1. Relative Strength 52 weeks = 57
  2. Cash Flow 5 -year Average = 7.02

Growth

  1. Net Income ($mil) 12/2011 = 573
  2. Net Income ($mil) 12/2010 = 948
  3. Net Income ($mil) 12/2009 = 647
  1. EBITDA ($mil) 12/2011 = 6046
  2. EBITDA ($mil) 12/2010 = 3509
  3. EBITDA ($mil) 12/2009 = 2155
  1. Cash Flow ($/share) 12/2011 = 8.43
  2. Cash Flow ($/share) 12/2010 = 8.12
  3. Cash Flow ($/share) 12/2009 = 5.7
  1. Sales ($mil) 12/2011 = 15351
  2. Sales ($mil) 12/2010 = 7042
  3. Sales ($mil) 12/2009 = 4974
  1. Annual EPS before NRI 12/2009 = 3.6
  2. Annual EPS before NRI 12/2010 = 3.39
  3. Annual EPS before NRI 12/2011 = 2.21

Dividend history

  1. Dividend Yield = 7.3
  2. Dividend Yield 5 Year Average 12/2011 = 6.11
  3. Dividend 5 year Growth 12/2011 = 72.26

Dividend sustainability

  1. Payout Ratio = 1.27
  2. Payout Ratio 5 Year Average = 0.68
  3. Change in Payout Ratio = 0.59

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 4.09
  2. EPS Growth Quarterly(1)/Q(-3) = 127.63
  3. ROE 5 Year Average 12/2011 = 10.29
  1. Current Ratio 06/2011 = 0.88
  2. Current Ratio 5 Year Average = 0.76
  3. Quick Ratio = 0.88
  4. Cash Ratio = 0.38
  5. Interest Coverage Quarterly = 1.62

Company: Ares Cap Cp (ARCC)

Free cash flow=$-674 million

Growth

  1. Net Income ($mil) 12/2011 = 319
  2. Net Income ($mil) 12/2010 = 692
  3. Net Income ($mil) 12/2009 = 203
  1. EBITDA ($mil) 12/2011 = 437
  2. EBITDA ($mil) 12/2010 = 318
  3. EBITDA ($mil) 12/2009 = 163
  4. Cash Flow ($/share) 12/2011 = 1.68
  5. Cash Flow ($/share) 12/2010 = 1.41
  6. Cash Flow ($/share) 12/2009 = 1.3
  1. Sales ($mil) 12/2011 = 634
  2. Sales ($mil) 12/2010 = 483
  3. Sales ($mil) 12/2009 = 245
  1. Annual EPS before NRI 12/2007 = 1.43
  2. Annual EPS before NRI 12/2008 = 1.42
  3. Annual EPS before NRI 12/2009 = 1.35
  4. Annual EPS before NRI 12/2010 = 1.43
  5. Annual EPS before NRI 12/2011 = 1.56

Dividend history

  1. Dividend Yield = 9.50
  2. Dividend Yield 5 Year Average 12/2011 = 13.56
  3. Dividend 5 year Growth 12/2011 = -4.56

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.92
  2. Payout Ratio 5 Year Average 12/2011 = 1.08

Performance

  1. Next 3-5 Year Estimate EPS Growth rate = 11.5
  2. EPS Growth Quarterly(1)/Q(-3) = -154.84
  3. ROE 5 Year Average 12/2011 = 10.03
  1. Current Ratio 06/2011 = 1.3
  2. Current Ratio 5 Year Average = 1.94
  3. Quick Ratio = 1.32
  4. Cash Ratio = 0.73
  5. Interest Coverage Quarterly = 3.91

Company: Pennant Park Investment Corporation (PNNT)

Growth

  1. Net Income ($mil) 12/2011 = 10
  2. Net Income ($mil) 12/2010 = 17
  3. Net Income ($mil) 12/2009 = 36
  1. EBITDA ($mil) 12/2011 = 4
  2. EBITDA ($mil) 12/2010 = 12
  3. EBITDA ($mil) 12/2009 = 33
  4. Cash Flow ($/share) 12/2011 = 1.01
  5. Cash Flow ($/share) 12/2010 = 0.88
  6. Cash Flow ($/share) 12/2009 = 0.78
  1. Sales ($mil) 12/2011 = 92
  2. Sales ($mil) 12/2010 = 60
  3. Sales ($mil) 12/2009 = 45
  1. Annual EPS before NRI 12/2007 = 0.35
  2. Annual EPS before NRI 12/2008 = 0.35
  3. Annual EPS before NRI 12/2009 = 1.08
  4. Annual EPS before NRI 12/2010 = 1.09
  5. Annual EPS before NRI 12/2011 = 1.25

Dividend history

  1. Dividend Yield = 11.30
  2. Dividend Yield 5 Year Average 12/2011 = 11.54
  3. Dividend 5 year Growth 12/2011 = 8.53

Dividend sustainability

  1. Payout Ratio 06/2011 = 0.88
  2. Payout Ratio 5 Year Average 12/2011 = 0.95

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -14.56
  2. Next 3-5 Year Estimate EPS Growth rate = 10
  3. EPS Growth Quarterly(1)/Q(-3) = -103.13
  4. ROE 5 Year Average 12/2011 = 9.35
  1. Current Ratio 06/2011 = 0.91
  2. Current Ratio 5 Year Average = 0.95
  3. Quick Ratio = 1.14
  4. Cash Ratio = 1
  5. Interest Coverage Quarterly = 2.6

Company: Solar Capital (SLRC)

Levered free cash flow = $36.7 million

Growth

  1. Net Income ($mil) 12/2011 = 61
  2. Net Income ($mil) 12/2010 = 142
  3. Net Income ($mil) 12/2009 = 87
  1. EBITDA ($mil) 12/2011 = 72
  2. EBITDA ($mil) 12/2010 = 156
  3. EBITDA ($mil) 12/2009 = 90
  1. Cash Flow ($/share) 12/2011 = 2.24
  2. Cash Flow ($/share) 12/2010 = 2.08
  3. Cash Flow ($/share) 12/2009 = N/A
  1. Sales ($mil) 12/2011 = 132
  2. Sales ($mil) 12/2010 = 125
  3. Sales ($mil) 12/2009 = 110
  4. Annual EPS before NRI 12/2009 = 0.82
  5. Annual EPS before NRI 12/2010 = 2.08
  6. Annual EPS before NRI 12/2011 = 2.25

Dividend history

  1. Dividend Yield = 10.9
  2. Dividend 5 year Growth 12/2011 = N/A

Dividend sustainability

  1. Payout 5 = 1.5
  2. Payout Ratio 5 Year Average 12/2011 = 0.7

Performance

  1. Percentage Change Price 52 Weeks Relative to S&P 500 = -14.6
  2. EPS Growth Quarterly(1)/Q(-3) = -107.55
  3. ROE 5 Year Average 12/2011 = 19.54
  1. Current Ratio 06/2011 = 0.13
  2. Current Ratio 5 Year Average = 1.3
  3. Quick Ratio = 0.13
  4. Cash Ratio = 0.06
  5. Interest Coverage Quarterly = 18.21

Conclusion

The markets are still in a corrective phase and will most likely remain volatile for the better part of the second quarter. Long-term investors can use strong pullbacks to slowly start deploying money into long-term investments. One of the best ways to do this is by selling naked puts at strikes you would not mind owning the stock at. As for Citigroup, it would only make for a good investment if the suggested strategy is put into play. At that junction, the risk to reward ratio would move in favor of the buyer.

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: Is Citigroup A Good Long-Term Investment?

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