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With stock markets all over the world spurred by Ben Bernanke's boost, the other major news on Friday has gone almost unnoticed. Unitedhealth Group (UNH) is replacing Kraft Foods (KFT) in the Dow 30 (DIA). The move was more due to the Kraft spin off, with doubts over the market cap of the "Mondelez" division. While addition/deletion from the indices used to have a much bigger impact on a company's stock price, this news hasn't sparked either a spike or a sell off. At the time of this writing, UNH is up about 0.65%, while KFT traded down by 0.3%.

Marketwatch just published a piece that Unitedhealth has big shoes to fill, as Kraft is a well known dividend stock. This prompted us to take a look at how Unitedhealth's dividend prospects are and how the company stacks up against Kraft. Though the two companies operate in totally different spaces, this analysis might be helpful for those who look at indexing. Let us get into the details.

  • Yield: Unitedhealth's current yield is about 1.6%, which pales in comparison to the stock it is replacing. Kraft's yield is 2.9%.
  • Payout Ratio: However Unitedhealth's payout ratio is a meager 17%, while Kraft's stands at close to 58%. This gives a lot of room for Unitedhealth to increase its payout in the future.
  • Dividend Increase: Speaking of dividend increases, Kraft has been paying the same 29 cents per share ever since the Altria (MO) spin off. Investors holding the three spin off stocks -- Altria , Philip Morris International (PM), and Kraft -- would attest the fact that Kraft hasn't matched its "siblings" in dividend returns.
  • In the same time period, Unitedhealth's dividend per share has gone up from 3 cents to 21 cents.
  • Unitedhealth increased its dividend by an average of 30% over the past couple of years, and if anything, its addition to the Dow will spur the company to increase its dividends periodically and also try matching the average yield of the Dow 30, which now stands at about 2.89%. And this looks quite possible, given the low payout ratio and company's dominance in its sector.
  • Cash on Hand: Apart from payout ratio and earnings, a company's cash on hand gives investors an idea of whether their dividends are safe. Unitedhealth's cash on hand has generally been on an uptrend, as shown below:

(click image to enlarge)

Source: Ycharts.com

  • Valuation: In terms of valuation, Unitedhealth seems pretty fair with a PE ratio of about 10, matching its expected growth rate.

Conclusion: While Kraft has always enjoyed the status of a good dividend stock, it seems reasonable to believe that Unitedhealth is well prepared to at least match, if not surpass, the long term dividend returns for investors. Rising health insurance costs, while troubling for the public, are good for Unitedhealth and its peers.

Source: United Health's Dividend Prospects