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Research analyst, valuentum
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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™ (click here for more information). In this article, let's evaluate the investment merits of Baxter Intl (BAX), as well as its dividend under this unique but yet very straightforward framework.

Investment Considerations

Return on Invested Capital

Baxter Intl's Dividend

(click to enlarge)

Baxter Intl's dividend yield is above average, offering roughly a 3% annual payout at recent price levels. We generally prefer yields above 3% and don't include firms with yields below 2% in our dividend growth portfolio. So Baxter is certainly worth watching as a income idea.

For starters, we think the safety of Baxter Intl'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. Click here for a clip on why Valuentum's President of Equity Research Brian Nelson thinks why using cash flow to analyze dividends is a very important consideration for income investors.

For Baxter Intl, this score is 2, revealing that on its current path the firm can cover its future dividends with net cash on hand and future free cash flow. We also 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 Baxter Intl'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 Baxter Intl. The firm has a solid cash flow profile, despite risks to its business.

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 Baxter Intl's case, we currently 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 things considered, the growth and safety of Baxter's dividend are attractive, and we are strongly considering the firm for addition to our dividend-growth portfolio.

Source: Why We Like Baxter's Dividend