If you're looking for a good dividend stock for the long term, it's important to look beyond current dividend yields to the company's prospects for growth and the strength of its free cash flow. A robust free cash flow makes it more likely that the company will increase its dividend payout in the future. 

Two companies that have strong free cash flows (FCF), and room for continued solid stock-price appreciation and dividend increases are Johnson & Johnson (NYSE:JNJ) and Walt Disney (NYSE:DIS).

Machine printing $100 bills.

Image source: Getty Images.

The diversified healthcare giant 

Johnson & Johnson is probably best known for its consumer product staples, such as Band-Aid adhesives and Listerine mouthwash. Over the years, however, the company has enlarged its empire to include what's now the world's most complete medical devices business and the fifth-largest pharmaceuticals business.

J&J's dividend is currently yielding 2.55%. Thanks to the cash flowing in from its diverse businesses, which are largely immune to economic downturns, the company has raised its dividend for 55 consecutive years. This impressive feat makes it a "dividend aristocrat," one of the only approximately 50 S&P 500 constituency companies that have increased their dividend payouts for at least 25 consecutive years. Over the last 10 years, the company's dividend has increased more than 100%, so it's more than doubled:

JNJ Dividend Chart

Data by YCharts.

Here's a look at J&J's free cash flow (FCF), FCF margin (the percentage of revenue a company converts to cash), and cash dividend payout ratio (the percentage of a company's FCF that it pays out in dividends) over the last 10 years. 

JNJ Free Cash Flow (TTM) Chart

Data by YCharts.

J&J converts 21.6% of the revenue it takes in into free cash flow, which has resulted in the company spewing off $16.3 billion in FCF over the trailing-12-month period. The company's FCF margin has increased over the years, which is visible in a longer-term chart. We can probably largely attribute this rising FCF margin to the company's expansion beyond its personal care product roots into higher-profit-margin businesses, particularly pharmaceuticals.

The pharmaceuticals business is the company's fastest-growing segment, and should continue to be its growth engine. Last year, J&J announced an ambitious plan to bring to market 10 novel drugs by 2019 that have blockbuster potential, meaning they could each generate at least $1 billion in annual sales. 

J&J is paying out just over 53% of its free cash flow in dividends. While many factors come into play, a dividend cash ratio of less than about 60%-65% suggests that future dividend increases are likely in the cards. So J&J's cash dividend payout ratio is well within a safe range, and suggests that investors should be able to look forward to continued dividend hikes in the years to come. 

Boy with Goofy at Disneyland.

Image source: Disney.

The diversified family entertainment giant

Since its founding as an animation studio in 1923, Disney has expanded well beyond its iconic flagship movie studio. The company's empire includes three additional movie studios (Pixar, Marvel, and Star Wars-creator Lucasfilm), its legendary theme parks, its broadcast and cable TV networks (including ESPN and ABC-TV), and its far-reaching consumer-goods business.

Disney's dividend -- which is paid in semiannual increments -- is currently yielding 1.42%. This is a modest yield, so Disney isn't a good stock for investors who need higher-yielding income investments now; however, it's a top choice for investors who want a stock with solid total capital appreciation potential that has the potential to blossom into quite a dividend stock over time.

Disney has paid dividends for some time, but it's only been in more recent years that the company has increased its commitment to rewarding its investors through dividend payments. Disney has raised its annualized dividend payment for seven consecutive years, with the most recent hike coming in December, when it boosted the dividend by 10% to a semiannual payout of $0.78 per share.

DIS Dividend Chart

Data by YCharts. The magnitude of the increase in 1999-2000 and the drop in 2015-2016 are misleading, as they reflect transitions in Disney's dividend payment frequency from quarterly to annual in 1999 and then to semiannual in 2015. For this reason, I didn't show the same percentage change chart like I did for J&J. It's best just to take in the general trend here. 

Here's a look at Disney's FCF, FCF margin, and cash dividend payout ratio over the last 10 years. 

DIS Free Cash Flow (TTM) Chart

Disney converts 15.2% of the revenue it takes in into free cash flow, which resulted in the company throwing off $7.8 billion in FCF over the trailing-12-month period. This percentage has increased in more recent years, as the preceding chart shows. We can probably attribute the rise in FCF margin to some of the shrewd moves CEO Bob Iger has made during his tenure, including acquiring Pixar, Marvel, and Lucasfilm. 

The House of Mouse is paying out 30.6% of its FCF as dividends, so it has plenty of room to continue to increase its dividend payout. While Disney could immediately double its dividend payment, it's a positive that this won't happen. The company likes to maintain a sizable cash hoard, so that it has the capability to continue to significantly invest for growth and take advantage of attractive acquisition candidates. Over time, though, it's likely Disney will mature into more of higher-yielding dividend stock, in my opinion.

In short, J&J and Disney offer investors the best of both worlds: the potential for stock-price appreciation plus continued dividend increases. 


This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.