I love dividends. There is nothing like getting cash in your pocket to drive home the fact that your shares represent part ownership in a real business. They are also an unfakeable sign of financial health. You can't pay dividends using earnings from accounting games.
Most lists of dividend kings (or aristocrats) focus exclusively on the number of years a company has had uninterrupted dividend increases. There is an elegant logic to this, as it shows a great degree of fiscal discipline on management's part, and it also provides a degree of future security: After all, management knows that dividend increases are expected each year and not doing so would create a shareholder backlash. It would also call into question the financial health of the company.
Consecutive annual dividend increases is a nice yardstick, but I would like to nominate a slightly more inclusive measure of management's effective use of cash: The earnings conversion ratio. This is simply the total amount cash that is returned to shareholders (through dividends and buybacks) divided by total earnings over the last 10 years. Any company that manages a ratio of over 60% while managing to grow earnings at least 8% a year is a dividend King in my book.
Take Microsoft (MSFT).
It wasn't so long ago that tech companies saw paying dividends as a sign of weakness. It was an admission that you had run out of ideas about how to expand your empire. After the tech bubble burst, however, one tech giant after another got dividend religion, perhaps none more so than Microsoft. After a slow start in 2003 it exploded out of the gate with a special $3 / share dividend in 2005.
Over the last 10 years Microsoft has reported a total of $139 billion in earnings.
In total, Microsoft has distributed $64.2 billion in dividends over the last 10 years.
On top of that, they bought back a net of 2.6 billion shares of stock, which has a present value of $70 billion. You will notice that I don't give them credit for the amount that they spent to buy back shares (they actually spent $88.2 billion) but only the current value with a 10% haircut, just to be conservative.
Finally, I look at the tangible book value to make sure that the company is actually paying dividends out of earnings. In Microsoft's case, the tangible book value (I strip out goodwill and any other intangibles I can find) actually fell by 6.6 billion, so that gets subtracted from the payout totals.
Adding it all up, Microsoft gave back $64.2 + $70 -$ 6.6 = $127.6 billion out of a total earnings of $139 billion for an Earnings Conversion Ratio of 92% !!!
That's amazing. There are very few companies out there that can claim to have returned 92 cents of every dollar back to shareholders over the past ten years.
A final check is to look at the earnings growth. Steady growth means room for dividend increases in the future. In Microsoft's case, earnings grew at a very respectable 11% compounded over the last ten years, easily satisfying my 8% hurdle.
Taken together, I would say that Microsoft deserves to be called a Dividend King.
On a final note, being a Dividend King does not make a stock a buy, just a great company to own if you can get it at a good price. With that in mind, let's look at what a slice of Microsoft will cost you today.
MSFT PE Ratio data by YCharts
As you can see, Microsoft is trading at a P/E of less than 11 (and that doesn't even strip out the cash on the balance sheet), making it not only a great company, but also a good buy.
Do you think your favorite dividend stock meets my test to be a King?
Disclosure: I am long MSFT.
