Although analyzing historical trends is important, we think assessing what may happen to the dividend in the future is even more important. That is why we created a forward-looking assessment of dividend safety through our innovative, predictive dividend-cut indicator, the Valuentum Dividend Cushion™ (click here for more information). We use our future forecasts for free cash flow and expected dividends and consider the company's net cash position to make sure that each company is able to pay out such dividend obligations to you -- long into the future. In this article, let's evaluate the investment merits of Johnson & Johnson (JNJ), as well as its dividend.
Return on Invested Capital
Johnson & Johnson's Dividend
Johnson & Johnson's dividend yield is above average, offering a 3.4% annual payout at recent price levels. We prefer yields above 3%, and don't include firms with yields below 2% in our dividend-growth newsletter portfolio.
We think the safety of Johnson & Johnson'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, 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 Johnson & Johnson, this score is 2.6, revealing the firm has a nice "cushion" and the capacity to pay out its expected future dividends. 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. Just recently, SuperValu (SVU) registered -12.5 on this metric before it cut its dividend, while JC Penney (JCP) registered a 0.9 (both below parity). For a read on how we warned investors of SuperValu's impending dividend cut, please click here. We use our dividend cushion as a key decision component in choosing companies for addition to the portfolio of our Dividend Growth Newsletter.
Now on to the potential growth of Johnson & Johnson'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 Johnson & Johnson. 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 Johnson & Johnson's case, we think the shares are undervalued, so the risk of capital loss is low.
All things considered, we think Johnson & Johnson is a slam-dunk dividend play. The firm is undervalued, its yield is attractive, and the dividend has strong growth prospects, in our opinion. The glossary below shows how we rate a company's dividend in each key area:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Some of the firms mentioned in this article may be included in our actively-managed portfolios.