Military industrial giant General Dynamics Corporation (GD 1.59%) has increased its dividend every year for 26 consecutive years. That impressive record of consistent dividend hikes makes it a Dividend Aristocrat. However, achieving that lofty status doesn't mean that this key U.S. defense contractor should get a pass when it comes to researching the safety of its dividend. While General Dynamics' dividend history suggests the current dividend is on solid ground, here are some key factors you need to keep an eye on, including the company's leverage and the payout ratio.
An elite designation
Not many companies manage to achieve Dividend Aristocrat status, which takes 25 years' worth of annual dividend increases to earn. Being able to do that speaks to a business that has withstood the test of time and succeeded through multiple business cycles. While selling marine systems, aerospace products, and other defense products and services to the U.S. government is a pretty consistent business overall, it does have its ups and downs. So General Dynamics deserves some serious credit for 26 years of consistent dividend increases.
An impressive history of annual increases doesn't mean a dividend is safe from being cut in the future. Image source: Getty Images.
You don't magically achieve that kind of success, though. It starts from the foundation of the business and can only continue if management remains on solid financial ground. That is why one of the first places you should look to see if General Dynamics' dividend streak can continue is its balance sheet. At the end of the third quarter of 2017, long-term debt was roughly $4 billion, which was a very modest 25% (or so) of the capital structure.
The company's debt levels fluctuate over time, as you would expect. However, management has used leverage conservatively over the past decade. That's a good trend to see and, at this juncture, there's no reason to believe that's going to change. On that score, it's worth noting that General Dynamics' current ratio is solidly over 1 as well, meaning it shouldn't have any trouble paying its near-term bills, something that might otherwise lead to a need for more long-term debt.
Another important question is the size of the dividend. Currently, General Dynamics' yield is 1.5%, a modest number, but that's not the key issue to examine. A more important metric to look at is the payout ratio, which compares earnings and dividends. General Dynamics' payout ratio is around 30%, which is a reasonable number for any company. It not only suggests that the current dividend is safe, but that there's room to increase the dividend in the future.
Dividends, however, are actually paid out of cash flow, not earnings. So you'll also want to examine the company's free cash flow over time. As the chart below shows, free cash flow per share fluctuates, but has handily covered the dividend even during years like 2012 when General Dynamics' earnings dipped into the red. Looking at both the payout ratio and free cash flow per share should provide investors with comfort in the strength of the dividend here.
GD free cash flow per share (TTM) data by YCharts.
One more factor that's worth pointing out with General Dynamics is its diversification. While the U.S. government is its largest customer by far, there's actually more than one customer under that big government umbrella. General Dynamics' business is broken up into four divisions: aerospace (around 25% of revenue), combat systems (19%), information systems and technology (nearly 30%), and marine systems (roughly 25%). So its business is diversified across everything from IT to airplanes to boats, which means it doesn't rely on just one big government contract but a broad collection of deals. That's another fact that should help build confidence in General Dynamics' ability to support and raise its dividend over time.
The takeaway
When you step back and look at General Dynamics' impressive dividend history, conservative finances, solid earnings and cash flow, and diversified business, you should feel good about the future of the defense contractor's dividend. Although you need to perform annual checkups, at the very least, it looks like today's dividend is extremely safe. Better yet, future dividend hikes are likely at this Dividend Aristocrat.
