Unfortunately for the individual investor and time-strapped financial advisor, most dividend analysis that we've seen out there is backward-looking, meaning it rests on what the company has done in the past (how long it has raised its dividend, etc.). We're looking to change that view. In this article, let's evaluate the investment merits of Macy's (NYSE:M) as well as its dividend under a new framework, the Valuentum Dividend Cushion. For a read on how we calculate the intrinsic value of Macy's via an extensive three-stage discounted cash-flow model, please click here.
Return on Invested Capital
Macy's dividend yield is about average, offering just at 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 (please see links on our left sidebar for more information).
We think the safety of Macy's dividend is good (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. For Macy's, this score is 1.6, revealing that on its current path the firm may can cover its future dividends with net cash on hand and future free cash flow. Basically, if the score is above 1, the company has the capacity to pay out its expected future dividends. 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. 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.
Now on to the potential growth of Macy'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 Macy's. The company has solid cash-flow generating capacity.
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 Macy's case, we think the shares are fairly valued, so the risk of capital loss medium. If we thought the shares were undervalued, the risk of capital loss would be low.
All in all, we'd wait for a dividend increase or a pullback in the shares to call Macy's a dividend growth gem.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.