Dividend stocks are an excellent way to build your wealth over time. According to Factset, from 1991 to 2015, dividend payers outperformed non-dividend payers 9.7% to 4.2%.
Dividend-paying companies can be great investments because they must generate cash flow and manage their capital effectively. Cincinnati Financial (CINF 2.07%) is a shining example of this, having increased its dividend for decades, and could set you up for a lifetime of passive income.
Cincinnati Financial is a cash flow machine
Cincinnati Financial writes insurance policies for businesses and individuals across various products, including homeowners, automotive, and property insurance.
When it comes to dividend-paying stocks, Cincinnati Financial is one of the best. Dividend Kings are companies in the S&P 500 that have increased their dividend payout for 50 years or more. Cincinnati Financial increased its dividend for 62 consecutive years, which only eight other companies have accomplished.
Insurers like Cincinnati Financial make good investments because of their ability to generate cash flow. Free cash flow (FCF) measures the amount of cash left over after a company pays for operating expenses and capital expenditures. It can use that cash to pay down debt, pay dividends to shareholders, or repurchase its stock.
Cincinnati Financial's FCF has grown at a 13.7% compound annual growth rate (CAGR) over the last decade, and the company generated $1.8 billion in FCF last year.
CINF Free Cash Flow data by YCharts
It wasn't always smooth sailing for the insurer
FCF growth doesn't just happen. Insurers must take on policies with lower risk and price them appropriately to give themselves plenty of room to cover claims. Insurers measure how well they manage risk through the combined ratio -- claims paid out plus operating expenses, divided by premiums written. A ratio under 100% is desirable because it means a company takes in more premiums than it pays out in claims, and the lower the ratio, the better.
Cincinnati Financial struggled to balance risks from 2008 to 2011. During this time, the company averaged a 104% combined ratio, citing a weak economy and challenging environment for insurers. Impressively, the company maintained its dividend raises through this challenging period -- a testament to its capital management.
In May 2011, it hired its current CEO, Steve Johnston, who helped right the ship. Under Johnson's leadership, the insurer upgraded its predictive analytic models to measure risks and price policies profitably. Since then, Cincinnati Financial has averaged a combined ratio of 94.6% -- beating the property and casualty industry average of 99% during the same period.
Data source: CINF 10-K filings, Statista and NAIC for industry averages. Chart by author.
Cincinnati Financial improved its predictive models a decade ago and has constantly updated them ever since. The insurer uses artificial intelligence (AI) models to identify risky markets and credits these models with helping it avoid higher-risk areas -- like the coast where Hurricane Ida made landfall in August 2021.
It should have no problem growing its dividend
The payout ratio is useful when analyzing dividend stocks, because it tells you how much a company pays in dividends compared to earnings. If this ratio is above 100%, it means a company pays a dividend above its earnings, and the dividend will be difficult to maintain. According to Wellington Management and Hartford Funds, a safe payout ratio is around 41%.
CINF Payout Ratio data by YCharts
Last year, Cincinnati Financial's payout ratio was a meager 19%, suggesting this Dividend King should have no problem paying its dividend as we move forward -- making this a stellar stock that could bring you a lifetime of passive income.
