If there's anything better than a company that manages its business well enough to continuously generate growing free cash flow, it's one that shares that cash with shareholders through dividend payments, and raises that dividend as free cash flow increases.
With free cash flow and dividends in mind, I set out to find a few companies that have been increasing their dividend payments, have ample room to increase their dividend, and trade at a reasonable valuation. My screen did not impose a limit on yield, since this exercise was meant to cull future investing ideas, not investments I'm making today. Here's a synopsis of the three stocks I found:
Dialing up a dividend payer
Because they operate in a more favorable competitive environment than that of the U.S. while generating robust free cash flow, a few foreign telecom companies already reside in the Motley Fool Income Investor portfolio. With their healthy dividend payments, they're performing quite well as a group.
A telecom opportunity that lacks the yield to qualify as a pick just yet is Nokia
A mid cap with growth potential
As with our other two companies mentioned earlier, Polaris generates plenty of free cash flow. But with a payout ratio that is 24.5% of free cash flow, there is plenty of room for the 2.1% yield to rise in the future. The final piece of the puzzle is the company's motorcycle business, which while small at about 4% of revenues is growing fairly quickly despite tough competition from brand-name leader Harley-Davidson
A consumer staple
Our last stock is a consumer products company with a strong brands that offer a predictable and solid dividend. Paper products giant Kimberly-Clark's
As is common for businesses with repeat-purchase dynamics, Kimberly-Clark boasts strong free cash flow and returns on equity and assets. And since we're talking dividend growth, I must say Kimberly-Clark doesn't disappoint, with a payout ratio consistently below 40% and regular increases to its current payout of 2.9%.
Foolish final thoughts
Each of these three companies misses one mark that would make it an immediate candidate as an official recommendation for our Motley Fool Income Investor service: a strong dividend yield. As a general rule, we prefer companies that offer a dividend yield greater than 3%, increase their dividend regularly, have businesses that generate consistent free cash flow, and have funds left over after paying the dividend. It's not an easy set of criteria to meet, but it is a powerful combination that treats investors very well over time.
That said, all three make for good watch list candidates because they do meet most of the qualities of solid dividend payers and in the near future a little volatility may provide an attractive buying opportunity.
If you're interested in learning more about companies that generate strong free cash flow and pay you to hold their shares, consider a free 30-day trial to Motley Fool Income Investor. Over the last two years, lead analyst Mathew Emmert has delivered an average total return of 16.8% against the S&P 500's 9.4%. As part of your trial, you get access to back issues and dedicated discussion board, where you can talk with like-minded investors. There's no obligation to buy if you aren't completely satisfied.