Some dividends have staying power. Companies delivering enduring dividends tend to back such often-rising payouts with robust business and financial achievement.
Fragile dividends, meanwhile, arise because of weaker operational and financial characteristics. Those are the dividends to avoid. However, fragile dividends often tempt us because of high dividend yields.
How to tell the difference
Under the spotlight today, two FTSE 100 firms: Barclays (LSE: BARC) the bank and Diageo (LSE: DGE) the alcoholic beverage provider with well-known brands.
These firms operate in different sectors, but they both have a reasonable dividend yield. At the recent share price of 260p, Barclays forward yield for 2015 is 3.6%. At 1867p, Diageos is 2.9%.
Lets run some tests to gauge business and financial quality, and score performance in each test out of a maximum five.
-
Dividend record
Barclays struggled to maintain its dividend, and didnt raise it in recent years, and Diageo has a decent dividend-raising record:
Ordinary dividends |
2010 |
2011 |
2012 |
2013 |
2014 |
Barclays |
5.5p |
6p |
6.5p |
6.5p |
6.5p(e) |
Diageo |
38.1p |
40.4p |
43.5p |
47.4p |
51.7p |
Over four years Barclays dividend advanced 18%, delivering a compound annual growth rate of 4.3%. Diageos moved forward by 36%, achieving a growth rate of 7.9%.
For their dividend records, Im scoring Barclays 2/5 and Diageo 3/5.
-
Dividend cover
Barclays expects its 2015 adjusted earnings to cover its dividend around 2.7 times. Diageo expects cover from earnings of about 1.7 times. My ideal dividend payer would cover its cash distribution with earnings at least twice.
However, cash pays dividends, so its worth digging into how well, or poorly, both companies cover their dividend payouts with free cash flow thats cash flow after maintenance capital expenditure.
On dividend cover from earnings, though, Barclays scores 4/5 and Diageo 3/5.
-
Cash flow
Dividend cover from earnings means little if cash flow doesnt support profits.
Here are the firms recent records on cash flow compared to profits:
Barclays |
2010 |
2011 |
2012 |
2013 |
2014 |
Operating profit (m) |
6,007 |
5,710 |
657 |
2,892 |
6,300(e) |
Net cash from operations (m) |
18,686 |
20,079 |
(13,823) |
(25,174) |
? |
Diageo |
|||||
Operating profit (m) |
2,574 |
2,595 |
3,158 |
3,380 |
2,707 |
Net cash from operations (m) |
2,298 |
2,183 |
2,093 |
2,033 |
1,790 |
As we might expect, Diageos consumer goods business, with its repeat-purchase credentials, delivers steady cash flow that generally supports profits. Over the last three years, though, the cash supply from operations dwindled a bit.
Then we have Barclays. Cash flow at banks is a less useful indicator of business health than that at other types of business. Banks cash flow tends to be noisy, as we see here. Accounting quirkssuch as how the banks classify their loans and investments, for examplecan bolster or lower a cash-flow number artificially. It all adds to the opaque, black-box feel that surrounds banks, rendering them almost uninvestable, in my view.
Im scoring Barclays a benefit-of-the-doubt 3/5 for its cash-flow record and Diageo 3/5 also.
-
Debt
Interest payments on borrowed money compete with dividend payments for incoming cash flow. Thats why big debts are undesirable in dividend-led investments.
Most banks carry big external debts and Barclays balance sheet entry for debt securities exceeds thirteen times the level of its estimated operating profit this year. However, bank debts come in many forms, so thats not Barclays only exposure to borrowed money.
Diageo also uses a fair amount of other-peoples money, with debts running in excess of four times the level of operating profit.
Arguably, banking businesses require, and can justify, high debt loads. That said, they would make more secure investments with lower levels of borrowed money. Im awarding Barclays 1/5 and Diageo 2/5 for their approach to borrowings.
-
Degree of cyclicality
We saw in the financial crisis of the last decade how cyclical the banks are. Fluctuating share prices and valuations are the order of the day with banks such as Barclays, as macro-economic gyrations keep cash flows, profits and asset valuations bouncing around.
Diageo is far less cyclical. We keep consuming our favourite tipple no matter what the economic weather throws at us, although some cash-strapped customers probably switch to cheaper brands when the economic climate is tough.
Barclays scores 1/5 and Diageo 4/5.
Putting it all together
Here are the final scores for these firms:
Barclays |
Diageo |
|
Dividend record |
2 |
3 |
Dividend cover |
4 |
3 |
Cash flow |
3 |
3 |
Debt |
1 |
2 |
Degree of cyclicality |
1 |
4 |
Total score out of 25 |
11 |
15 |
Diageo wins this face-off, but neither firm is perfect by these measures, so my search for a dividend champion continues.
If you are serious about capturing an enduring stream of dividends from quality firms with robust financial and operational characteristics, you can download a wealth report prepared by our industry-leading analysts who navigate the dividend-investing minefield every day.
Successful dividend investing may not be as straightforward as it at first seems, but this useful document signposts more outstanding London-listed opportunities available right now. Make sure you stay well informed. Click here.
Get FREE Issues of The Motley Fool Collective
Get straightforward advice on whats really happening with the stock markets, direct to your inbox. Help yourself with our FREE email newsletter designed to help you protect and grow your portfolio wealth.
By providing your email address, you consent to receiving further information on our goods and services and those of our business partners. To opt-out of receiving this information click here. All information provided is governed by our Privacy Statement.
Kevin Godbold has no position in any shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.