Cashing In On Cash Flow

11/11/2013


Dividend-paying stocks in the S&P 500 Index have lagged so far this year, returning 29.4% versus 37.9% for nonpayers. And the highest-yielding stocks have delivered the weakest performance, as shown below.

HIGH YIELDS, LOW RETURNS
In the S&P 500 Index, high-yielding stocks have lagged lower-yielders this year, while dividend-payers as a whole have lagged nonpayers.
----- Average Total Return -----
--- Quadrix Scores ---
Stock Group
1
Month
(%)
3
Months
(%)
YTD
(%)
Value
Perfor-
mance
Nonpayers
2.7
4.4
37.9
55
53
Dividend payers
5.9
4.9
29.4
60
49
S&P 500
5.3
4.8
31.0
59
50
Yields of…
At least 4%
6.2
3.6
26.5
63
39
3% to 4%
6.0
3.8
28.7
54
46
2% to 3%
5.7
3.6
31.5
65
50
1% to 2%
5.3
5.6
29.3
60
52
Less than 1%
6.8
8.7
29.9
55
56
Note: Quadrix scores are percentile ranks, with 100 the best.

The picture looks better over long periods, but still not great. The top one-fifth of S&P 500 stocks based on dividend yield have outperformed most S&P 500 stocks in most of the 12-month periods since 1994. But the high-yield stocks tend not to have as many big winners, so their average returns are roughly equal to that of the average S&P 500 stock. With that in mind, when analyzing income stocks we prefer to look beyond yield.

A company's capacity and willingness to grow is dividend is crucial. Not surprisingly, cash-flow growth is key to dividend growth, as companies generating an increasing amount of cash can more easily boost payouts.

Can a company's cash-flow growth offer clues about its future dividend increases? To check, we analyzed cash-flow growth in the 12 months leading up to the announcement of dividend moves — specifically, the 312 dividend actions announced by S&P 500 companies in the first nine months of 2013.

Companies that initiated a dividend or announced hikes of at least 25% had the biggest median 12-month growth for cash from operations. But surging growth in cash flow doesn't necessarily lead to a big dividend hike, as shown in the table below. Free cash flow, a more volatile measure that includes dividend payments, had little predictive power regarding future dividend activity.  Note that banks and utilities, among the biggest dividend payers, rarely report cash flow.

DOES CASH FLOW PREDICT DIVIDENDS
In reviewing the 312 dividend actions made by S&P 500 stocks in the first nine months of this year, we found that companies with stronger growth in cash from operations were more likely to initiate a dividend or deliver large hikes. Free cash flow was far less effective as an indicator of dividend growth.
Median 12-Month Growth
-- Prior To Dividend Move --
2013 Dividend Moves
Cash From
Operations
(%)
Free
Cash Flow
(%)
No. Of
Companies
Initiated dividend
9.7
35.1
14
Raised dividend
At least 50%
9.6
(21.7)
23
25% to 50%
5.4
2.3
37
15% to 25%
4.1
4.3
44
10% to 15%
(2.0)
(7.5)
80
5% to 10%
2.8
(6.1)
61
Up to 5%
3.4
4.3
42
Cut dividend
(5.4)
(15.5)
11
Note: Multiple dividend actions by the same company are treated as separate moves.

The table below lists all of our recommended stocks that have increased their dividends this year. Below, we review four with a favorable cash-flow trend, a history of strong dividend growth, and a reasonable payout ratio (percentage of earnings paid out in dividends).

In May, Capital One Financial ($70; COF) boosted its quarterly dividend sixfold to $0.30 per share, restoring it to within 20% of the prerecession high. In the four quarters leading up to that dividend hike, cash from operations had risen 47% and free cash flow 46%. Both types of cash flow have continued to grow.

Rising analyst estimates project per-share profits of $1.53 in the December quarter, implying 9% growth, despite a projected 3% decline in sales. Growth in 2014 could become more challenging, though the stock looks cheap, earning a Value score of 89. Capital One's P/E ratio of nine is lower than more than 90% of stocks in our research universe and 23% below its own five-year average of 12. Capital One, with a 1.7% yield and both Quadrix sector-specific ranks above 90, is a Focus List Buy and a Long-Term Buy.


Shares of diversified manufacturer Dover ($91; DOV) briefly dipped on a mildly disappointing September-quarter report. However, the company is steadily expanding its operating profit margins. And cash from operations rose 6% through the first nine months of 2013, following three straight years of double-digit growth. Dover supplements organic growth with acquisitions. Management sees a rich pipeline of potential deals, especially within the energy sector, which accounts for about 27% of company sales.

Dover has raised its dividend for 58 years running, most recently hiking the quarterly payout 7% to $0.375 per share in August. Annualized dividend growth of 11% over the past five years ranks in the top 25% of our research universe. Dover complements the dividend with a stock-repurchase program that has lowered the share count by 8% in the past two years. Dover, yielding 1.6%, is a Focus List Buy and a Long-Term Buy.

 


Kroger ($43; KR) said Oct. 30 it is prepared to lower prices to preserve sales following the Nov. 1 expiration of a stimulus program that increased the availability of food stamps during the recession. Kroger also reiterated its guidance for fiscal 2014 ending  January, projecting per-share profits of $2.73 to $2.80, up 4% to 7%, versus the consensus of $2.80. Kroger has met or exceeded the consensus in eight straight quarters.

Kroger sees long-term growth of 8% to 11% for earnings per share. Despite plans for higher capital spending, management also says it remains committed to growing the dividend. Dividend growth has averaged 14% a year since Kroger reinstated its distribution in 2006. Both free cash flow and operating cash flow advanced in the four quarters leading up to Kroger's 10% dividend hike in September. Kroger, yielding 1.4%, is a Focus List Buy and a Long-Term Buy.


Schlumberger's ($92; SLB) quarterly dividend, currently $0.31 per share, has grown at double-digit rates in each of the past three years, including a 14% hike announced in January. Strong operating momentum and a sturdy balance sheet suggest continued growth is likely. The oilfield-services giant grew cash from operations by 69% to $5.94 billion in the first nine months of 2013. The shares, up 33% this year, haven't kept pace with the company's cash generation and trade at 13 times operating cash flow, a 21% discount to their three-year average.

While U.S. rig-contract prices could remain under pressure into 2014, land-drilling activity is beginning to improve, and management seems especially bullish about deepwater activity. Moreover, operating profit margins have steadily risen in 2013, and the company sees opportunities for more expansion through efficiency improvements. Schlumberger is a Focus List Buy and a Long-Term Buy.

RECOMMENDED STOCKS THAT RAISED DIVIDENDS THIS YEAR
Most of the 24 recommended stocks that have raised their dividends this year have also grown their operating cash flow over the last 12 months. To derive operating cash flow, we add most noncash costs back to earnings and adjust for changes in working capital. Free cash flow represents operating cash flow minus spending on dividends and capital projects. The stocks average payout ratios (dividends as a percentage of earnings) of 26%.
------ Last Dividend Hike ------
-- 12-Month Growth --
5-Year
Annualized
Dividend
Growth
(%)
Dividend
Payout
Ratio
(%)
Company (Price; Ticker)
Dividend
($)
Yield
(%)
Amount
(%)
Date
Announced
Operating
Cash Flow
(%)
Free
Cash
Flow
(%)
Aflac ($64; AFL)
1.48
2.3
6
October
(2)
(3)
8.6
22
American Express ($82; AXP)
0.92
1.1
15
March
(67)
(77)
3.8
19
Apple ($525; AAPL)
12.20
2.3
15
April
6
(13)
NA
31
BlackRock ($302; BLK)
6.72
2.2
12
January
0
(14)
16.8
43
Capital One Fin'l ($70; COF)
1.20
1.7
500
May
85
83
(9.5)
16
Cisco Systems ($23; CSCO)
0.68
2.9
21
April
12
(5)
NA
34
Comcast ($48; CMCSa)
0.78
1.6
20
February
(1)
(14)
41.7
36
CVS Caremark ($63; CVS)
0.90
1.4
38
February
(24)
(45)
26.4
25
Dover ($91; DOV)
1.50
1.6
7
August
27
65
10.9
29
EMC ($24; EMC)
0.40
1.7
Initiated
May
1
(6)
NA
23
Fifth Third ($19; FITB)
0.48
2.5
20
March & June *
NA
NA
(21.6)
28
Foot Locker ($35; FL)
0.80
2.3
11
February
(7)
(22)
1.3
30
Helmerich & Payne ($78; HP)
2.00
2.6
233
June
29
NA
19.6
11
J.P. Morgan ($52; JPM)
1.52
2.9
27
May
NA
NA
(3.4)
25
Kroger ($43; KR)
0.66
1.5
10
September
37
229
12.4
21
Lear ($79; LEA)
0.68
0.9
21
February
26
28
NA
12
Macy's ($46; M)
1.00
2.2
25
May
7
14
10.2
27
Magna Int'l ($85; MGA)
1.28
1.5
16
February
39
1,151
10.6
21
Qualcomm ($69; QCOM)
1.40
2.0
40
March
20
29
13.7
32
Schlumberger ($92; SLB)
1.25
1.4
14
January
53
NA
8.8
28
U.S. Bancorp ($38; USB)
0.92
2.4
18
June
NA
NA
(13.4)
31
Union Pacific ($153; UNP)
3.16
2.1
14
August
13
96
26.2
35
Visa ($197; V)
1.60
0.8
21
October
(40)
(58)
65.9
18
Wells Fargo ($43; WFC)
1.20
2.8
36
Jan. & April *
NA
NA
(3.4)
32
* Dividend change combines two dividend hikes made in 2013.    NA Not available.

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