Payout Ratios Could Rise Further

7/13/2015


In the year ended March, the S&P 500 Index paid $40.81 per share in dividends, up 14% from a year ago and 15% annually over the last four years. Year-to-year growth slowed to 9.5% for the June quarter but reached another record. Not surprisingly, the index's payout ratio — the percentage of earnings paid out in dividends — has also risen sharply.

The S&P 500 paid out 37% of its operating earnings in dividends in the 12 months ended March, up from 27% four years earlier. To check that trend against other payout ratios, we considered dividends as a percentage of cash flow (a shorthand version computed by adding depreciation and amortization back to net income) and free cash flow (cash from operations minus capital spending and dividends). Free cash flow isn't available for the index, but we used all three payout ratios in the table below, which groups stocks based on their yield or market sector.

PAYOUT RATIO COMPARISON

Not surprisingly, stocks with the highest dividend yields tend to pay out the highest portion of their profits or cash flows in dividends. We saw the same trend using our two alternative payout ratios — trailing dividends as a percentage of basic cash flow and as a percentage of free cash flow. Only 7% of stocks in the S&P 1500 Index and 10% of the index's dividend-payers yield more than 4%; those stocks' indicated dividends average more than 90% of trailing earnings, suggesting little flexibility for higher payouts going forward.

We generally avoid stocks with such high payout ratios. In fact, we try to keep the traditional payout ratio below 70% for utilities and below 50% for other companies. Basic cash flow is a simplified version of cash flow equalling net income plus depreciation and amortization.

---------------- Payout Ratios ----------------
S&P 1500 Group
(Number Of Companies)
Dividend
Yield
(%)
Indicated
Dividend
As % Of
Trailing EPS
Trailing
Dividend
As % Of
Basic Cash
Flow
Trailing
Dividend
As % Of
Free Cash
Flow
Dividend-payers (1,031)
2.3
44
29
56
Nonpayers (469)
0.0
0
1
1
All stocks (1,500)
1.6
31
20
35
Dividend Yield
Up to 1% (168)
0.6
17
11
28
1% to 2% (348)
1.5
31
23
47
2% to 3% (236)
2.4
47
34
66
3% to 4% (161)
3.4
68
39
97
Above 4% (118)
5.1
95
56
121
Sector
Consumer discretionary (237)
1.2
25
19
35
Consumer staples (69)
1.8
40
33
59
Energy (99)
1.5
22
14
23
Financials (303)
2.6
55
32
59
Health care (155)
0.6
12
10
15
Industrials (221)
1.3
26
20
40
Materials (100)
1.6
33
20
49
Technology (241)
0.8
16
12
20
Telecom services (14)
2.8
45
18
48
Utilities (61)
3.5
61
30
55

While rising payout ratios are always worth watching, today's ratios are not especially high by long-term standards. The S&P 500's traditional payout ratio of 37% and payout ratio of 25% based on shorthand cash flow are modestly higher than their respective 20-year averages of 34% and 25%. These observations suggest at least three conclusions:

• Payout ratios can't reach to the sky, and at some point dividend growth will likely revert back to the level of profit- or cash-flow growth. Still, ratios can expand further before many companies start feeling constrained. Double-digit growth is expected in the S&P 500 Index for full-year 2015, and continued growth is likely in 2016 unless the economy suffers an unexpected downturn.

• All three payout ratios tend to illustrate the same trends, which lends some confidence to our near-term dividend expectations.

• The spike in payout ratios in 2008 and 2009 reflects companies' reluctance to slash dividends in hard times. While the index's dividends fell year-over-year in seven consecutive quarters in 2009 and 2010, dividends were far less volatile than earnings or cash flows.

In the table below we present 12 A-rated dividend growers with modest payout ratios. The combination of low payout ratios and a historical commitment to dividend growth suggests these companies are both able and willing to keep the dividend rising in coming years. In the following paragraphs, we profile four stocks with low payout ratios:

In the 12 months ended March, real estate developer Jones Lang LaSalle ($172; JLL) grew per-share profits 46%, operating cash flow 29%, and free cash flow 46%. The company hiked its dividend 8% in April, and its cash-generating ability leaves open the possibility of far larger increases going forward. But for the moment, dividend growth is a passenger on the bus, not the driver.

Jones Lang puts $0.55 of every dollar of capital into mergers & acquisitions (most recently a real estate tax consultant), and another $0.30 to $0.35 into technology enhancements. In the near term, the company seems likely to continue modest dividend growth and focus on expanding its business — a strategy that has worked well lately. The shares have risen 15% so far this year and bounced 41% from October lows. Jones Lang LaSalle, yielding 0.3%, is a Focus List Buy and a Long-Term Buy.


On June 25, grocery-store chain Kroger ($75; KR) announced plans for a stock split and raised its quarterly dividend 14%, the ninth consecutive annual increase since beginning the payout in 2006. That new, higher dividend (which equates to a 1.1% yield) represents less than one-fourth of the company's profits over the last year, leaving plenty of room for growth.

Also last month, Kroger reported better-than-expected same-store sales for the April quarter and raised its target for fiscal 2016 ending January to 3.5% to 4.5%. Company executives said low gasoline prices — as well as low milk prices — tend to spur customers to buy more at supermarkets. In recent months, Kroger shoppers have splurged on pricier organic and high-end branded products, a good sign for both the economy and the company's results. Kroger's same-store sales have risen more than 5% in each of the last three quarters, while rival Whole Foods Market ($40; WFM) has averaged 3.7% growth during that period. Kroger, a Focus List Buy and Long-Term Buy, suits our growth-at-a-good-price investment approach.


What a difference five years makes. In 2010, Canada-based Magna International ($55; MGA) earned $2.16 per share and paid a dividend of $0.21 per share. This year, the auto-parts supplier is on pace to earn $4.70 per share (up 118% from five years ago) and pay a dividend of $0.88 per share (up 319%). While Magna yields 1.6%, slightly above its peer-group average, the expected year-ahead dividend equates to just 18% of trailing earnings.

On the surface, Magna's consensus 2015 growth targets aren't encouraging. Analysts expect sales to fall 10% and per-share profits to rise 4%. Blame the lackluster targets in part on weakness in the Canadian dollar and the euro relative to the U.S. dollar, not to mention the pending sale of a noncore business. However, analysts expect currency issues to clear up next year, driving growth of 5% in sales and 21% in profits. Magna is a Focus List Buy and a Long-Term Buy.


Irish drugmaker Shire ($239; SHPG) pays dividends semiannually, not quarterly, and has raised the dividend every year since it initiated the payout in 2004. With a yield of 0.3%, Shire's dividend isn't a key reason for purchasing the stock. However, that dividend has risen at an annualized rate of 28% over the last decade. With the indicated dividend gobbling up just 6% of trailing earnings, Shire has the flexibility to beef up its payout.

Over the last three years, Shire grew per-share profits at an annualized rate of 27%. Consensus per-share-profit targets call for growth of 8% this year and 16% next year — goals Shire seems capable of exceeding given its aggressive investment in drugs that treat rare conditions, also known as orphan drugs. While orphan drugs represent a powerful growth engine, Shire also makes treatments for attention-deficit hyperactivity disorder (ADHD) and human immunodeficiency virus (HIV). Shire is a Focus List Buy and a Long-Term Buy.

STOCKS CAPABLE OF DIVIDEND GROWTH
The A-rated stocks below have grown dividends at an annualized rate of at least 8% over the last three years — and over 10 years if they've paid a dividend that long. All 12 companies have a lower payout than their sector average based on at least two of the three payout ratios we calculated. Recommended stocks are listed in bold.
Annual. Div.
----- Growth -----
Operating
Cash-Flow Growth
------------ Payout Ratios ------------
Company (Price; Ticker)
Div.
($)
Yield
(%)
3
Years
(%)
10
Years
(%)
3
Years
(%)
10
Years
(%)
Indicated
Dividend
As % Of
Trailing EPS
Trailing
Dividend
As % Of
Basic
Cash Flow

Trailing
Dividend
As % Of
Free Cash
Flow

Quadrix
Overall
Score
Ameriprise Fin'l
($122; AMP)
2.68
2.2
34
39
7
7
31
30
19
95
Capital One Fin'l
($86; COF)
1.60
1.9
82
27
5
12
21
23
11
97
Comcast ($62; CMCSa)
1.00
1.6
26
NA
5
11
33
14
30
97
CVS Health ($104; CVS)
1.40
1.3
30
24
5
29
30
20
31
60
Disney ($115; DIS)
1.15
1.0
24
17
13
13
28
19
39
82
Jones Lang LaSalle
($172; JLL)
0.54
0.3
17
NA
26
14
6
4
8
93
Kroger ($75; KR)
0.84
1.1
17
NA
15
6
23
9
42
82
Macy's ($66; M)
1.44
2.2
36
17
5
6
33
17
32
76
Magna Int'l ($55; MGA)
0.88
1.6
16
8
19
7
18
11
50
82
MetLife ($54; MET)
1.50
2.8
24
12
10
6
26
29
11
99
Shire ($239; SHPG)
0.69
0.3
16
28
59
29
6
3
3
89
Southwest Airlines
($32; LUV)
0.30
0.9
137
30
25
7
12
7
14
87
Notes: Quadrix scores are percentile ranks, with 100 the best.     NA Not available because company doesn't have 10 years of divdend history.

 


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