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Most dividend analysis that we've seen out there assumes that historical analysis of a company's dividend track record is all that is necessary. Although analyzing historical dividend trends is important, we think assessing what may happen to the dividend in the future is even more important. After all, the recent financial crisis has taught us that rear-view-mirror investing is a recipe for disaster. In the spirit of our mission of serving the financial advisor and individual investor, we've created a forward-looking assessment of dividend safety in our innovative, predictive dividend-cut indicator, the Valuentum Dividend Cushion™. In this article, let's evaluate the investment merits of Parker-Hannifin (PH), as well as its dividend under this framework.

Investment Considerations

Return on Invested Capital

Parker-Hannifin's Dividend

Parker-Hannifin's dividend yield is about average, offering about a 2% annual payout at recent price levels. We prefer yields above 3%, and don't include firms with yields below 2% in our dividend growth portfolio.

We think the safety of Parker-Hannifin's dividend is excellent (please see our definitions at the bottom of this article). 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 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. We make complete forecasts for all three key financial statements. 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 Parker-Hannifin, this score is an impressive 4, revealing that on its current path the firm can easily cover its future dividends with net cash on hand and future free cash flow. 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. Also, for firms that have a score below 1 or that have a negative score, the risk of a dividend cut in the future is certainly elevated. In fact, the Valuentum Dividend Cushion caught all dividend cuts in our non-financial coverage universe, except for one, which subsequently raised its dividend above pre-cut levels (meaning it shouldn't have cut it in the first place). The Dividend Cushion also caught the recent cuts by JC Penney (JCP)--it had a -0.9 (negative 0.9) rating--and SuperValu (SVU)--it had a -11 (negative 11) rating. We use our dividend cushion as a key decision component in choosing companies for addition to the portfolio of our proprietary Dividend Growth Newsletter (please see our links on the left sidebar for more information).

Now on to the potential growth of Parker-Hannifin's dividend. 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, the company has a nice growth rate, and a nice dividend cushion, its future potential dividend growth would be excellent, which is the case for Parker-Hannifin. It's hard to argue that future growth won't be excellent, given the company's tremendous cushion.

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 Parker-Hannifin's case, we think the shares are fairly valued (they fall within our fair value range), so the risk of capital loss MEDIUM. However, please see here for an extensive valuation analysis of why Parker-Hanifin may have a date with $100 per share. If we thought the shares were undervalued, the risk of capital loss would be LOW (many firms in our coverage achieve such a rating).

All things considered, we like the potential growth and safety of Parker-Hannifin 's dividend, but we'd wait for a dividend increase or a pullback in the shares to consider it a nice income play.

Source: Parker-Hannifin's Dividend Growth Potential