This week's column is just begging to be written.
Why's that? Because the past week has been flooded with intriguing dividend action. ExxonMobil (NYSE: XOM), the world's largest company, got into the act on Wednesday by raising its dividend by more than 9%. Last week, Procter & Gamble (NYSE: PG) announced that it is raising its dividend for the 51st consecutive year. In the time since P&G started its streak, it has split its shares eight times, my mother was born, and bell-bottoms have been cool twice.
The real jaw-dropper, though, came on Tuesday when IBM (NYSE: IBM) announced a massive 33% increase in its annual dividend alongside a share buyback that could potentially take close to 10% of its outstanding shares off the table. This huge boost comes on the heels of last year's 50% hike. The announcement perked up the ears of greedy shareholders everywhere and IBM's shares climbed 6% over the next two days.
Sugar, spice, and plenty of nice, to be sure. Still, don't run off buying shares willy nilly just yet. Have you pondered whether these hikes are sustainable and if there is room for further growth?
Crunching some numbers
Since I dished out thoughts on Exxon in last week's column, I'll stick to new material and focus on the two new horses, IBM and P&G. In terms of sustainability, have the players bitten off more than they can chew? Let's explore.
|
Company
|
Dividend Increase
|
New Yield
|
Forward Payout Ratio
|
3-Year Average Payout Ratio
|
|
IBM
|
33%
|
1.6%
|
20%
|
16%
|
|
Procter & Gamble
|
13%
|
2.2%
|
43%
|
41%
|
Despite the hearty-sized increases, neither firm will be paying out much more over the next year in relative terms than it did over the past one. As such, both of these yields are more than sustainable. Sustainability is one thing, but growth is quite another. Do these companies have it in them to continue boosting their payouts above the general market?
|
Company
|
5-Year Dividend Growth Rate
|
Estimated 5-Year EPS Growth Rate
|
FCF / Revenue
|
|
IBM
|
21.7%
|
10.2%
|
10.4%
|
|
Procter & Gamble
|
13%
|
11%
|
12.4%
|
Both companies' dividends still have plenty of room to run over the next several years thanks to their impressive profitability. Even if these two were to fall short of low-double digit EPS growth (more likely for IBM given its sensitivity to the health of the tech sector), their ability to net more than a dime in free cash flow for each dollar of sales leaves the companies plenty of cash with which to buy back shares and reinvest in or expand operations. Either of these would result in a fatter payout.
While I'd be surprised to see IBM's dividend exhibit the kind of growth it has witnessed over the past five years, P&G shareholders should expect in the ballpark of 10% annual dividend growth over the next several years.
The Grandma Rule
One of many nuggets of wisdom I've gleaned from uberinvestor Warren Buffett is to stay within my circle of competence as an investor. Regular readers will recall that last week I shared that I've never bothered to value General Electric (NYSE: GE) due to its incredible number of moving parts and the difficulty in properly valuing each of its underlying segments.
I think of IBM in a similar way. If my grandmother asked me to explain IBM's business model to her, I wouldn't even know where to start. Once I did, her eyes would probably cross before I finished the first sentence. In order to better hone my commitment to investing only in businesses which I can easily understand, I'm instituting a new rule for my investments: The Grandma Rule. In order to receive funding from yours truly, a company's business model must be simple enough that I could explain it to my grandmother. Given its huge array of tech-related revenue streams, IBM is in clear violation of The Grandma Rule.
That being the case
It should come as no surprise then, that P&G is my favorite between these two. It isn't solely on the basis of The Grandma Rule, however. P&G has a bevy of consumer staples in its brand portfolio, including studs like Gillette, Duracell, Crest, and Pampers. P&G's top brands all have one thing in common: Consumers use and consume them quickly and repeatedly. Looking at the company's list of products, I spot four that I use on a daily basis and seven others which I have in my house at all times. If you looked in my bathroom, you'd assume P&G is paying me for product placements.
P&G's strong brands allow the company to charge premium margins. When you combine fat margins with products that millions of people use on a daily basis, you get significant, consistent cash flows. Trading at 22 times trailing-12-month earnings, P&G doesn't sound especially cheap, but investors need look no further than Total System Services (NYSE: TSS) and soon-to-be-private First Data Corp (NYSE: FDC) as examples of the premium multiples the market rewards for consistent cash flows. The current valuation is roughly in line with that of the past few years and on the low end of the company's historical range.
P&G's large and growing dividend, consistently massive free cash flows, and immensely valuable portfolio of brands make it a core holding in many dividend growth-centric portfolios. Keep P&G on your radar. Your grandmother will be proud of you.
Further reading
Looking for more dividend goodness? You can check out last week's issue of "The Weekly Dividend" or a couple of Foolish dividend-focused articles from the past week:
Interested in learning about stocks on the short list for consistent dividend growth? Check out James Early's
Motley Fool Income Investor
newsletter via a 30-day free trial.
Foolish editor Joe Magyer gave up caffeine cold turkey on Tuesday. Since then, he's punched through two walls, smashed one laptop, and wrestled three pit bulls. He apologizes for nothing. Joe does not own any stocks mentioned in this article. Joe's holdings and CAPS profile are always available for your viewing pleasure. First Data is an Inside Value pick. Like Joe, the Motley Fool's disclosure policy is intensely decaffeinated.
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