Dividend growth investing is lots of fun, especially if you have a systematic methodology to determining which companies' dividends are safe and which ones' aren't. That is why we 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 Danaher (NYSE:DHR), as well as its dividend under this unique but yet very straightforward framework.
Return on Invested Capital
Danaher's dividend yield is far below average, offering a paltry annual payout at recent price levels. In this day and age where investors demand a tangible return in the form of dividends (as a result of the financial crisis, which wiped out many investment accounts), we're a bit surprised the firm's board has not made a substantial move with respect to its payout yet. Further, the company's returns are not shabby and it is wildly profitable.
With such a small payout each year, the safety of Danaher'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 Valuentum 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. 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 Danaher, this score is 19.2, revealing that on its current path the firm can cover its future dividends with net cash on hand and future free cash flow over 19 times! The beauty of the Dividend Cushion is that it can be compared apples-to-apples across companies. For example, Wal-Mart (NYSE: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). We use our dividend cushion as a key decision component in choosing companies for addition to the portfolio of our Dividend Growth Newsletter (please see our links on the left sidebar for more information). The key takeaway here is that Danaher has substantial excess capacity to pay a higher dividend, and at its current pace, the firm will never be attractive to the income investor.
Now on to the potential growth of Danaher'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 Danaher. The board should seriously consider upping its payout.
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 Danaher's case, we think the shares are fairly valued, so the risk of capital loss medium. For a quick read on our DCF valuation of Danaher, please click here. If we thought the shares were undervalued, the risk of capital loss would be low.
All things considered, We like the potential growth and safety of Danaher 's dividend, but the yield is a bit low at this time. The board should strongly consider rewarding shareholders in the form of a higher dividend. We don't think the firm needs such excess cash-flow capacity to run its existing business or to consider external acquisitions.