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In this article, let's evaluate the investment merits of United Technologies (NYSE:UTX) as well as its dividend under a new framework, the Valuentum Dividend Cushion. For a read on how we calculate the intrinsic value of United Technologies via an extensive discounted cash-flow process, please click here.

Investment Considerations

Return on Invested Capital

United Technologies' Dividend

United Technologies' dividend yield is above average, offering just below a 3% annual payout at recent price levels. We think the safety of United Technologies' 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 United Technologies, this score is 2.5, 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. 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. 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).

Now on to the potential growth of United Technologies' 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 United Technologies. The firm's cash-flow generating capacity is top notch.

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 United Technologies' case, we think the shares are fairly valued, so the risk of capital loss is medium. If we thought the shares were undervalued, the risk of capital loss would be low.

All things considered, the growth and safety of United Technologies' dividend are appealing, and the firm is worth considering as a potential income play.

Source: Why United Technologies Is A Potential Income Play