The Dividend Aristocrats are a select group of currently 66 S&P 500 stocks with 25+ years of consecutive dividend increases. These 66 are large, US companies that have historically provided (slightly) better performance and (slightly) lower volatility than the S&P 500 as a whole. They are the ‘upper class’ dividend growth stocks and a great source for dividend growth investors. However, even Dividend Aristocrats could reduce or cut dividend payments and lose their status.
Reaching the 25 years of consecutive dividend increases is already an achievement. It demonstrated the company’s quality like stable earnings, solid fundamentals, and often strong histories of profit and growth over multiple market cycles.
The sustainability of dividend growth starts with a sound a sustainable business model. Some metrics can be used to check on this as well, such as payout ratio, free cash flow (FCF), and the forecast of the 5 years earnings per share (EPS) growth.
Based on the latter at least 6 dividend aristocrats are in the danger zone with respect to dividend growth.
Payout ratio matters
When analyzing dividend growth stocks, one should look at a stock’s payout ratio or the percentage of its earnings per share (EPS) or free cash flow (FCF) the company is spending on dividends. A payout ratio above 90% should be alarming and the dividend could be cut.
A recent example is Macy’s (M) which did cut its dividend in March 2020. Macy’s spent over 100% of its FCF on its dividend over the past 12 months, so it needed to suspend the dividend to weather the coronavirus crisis. Dividend Aristocrats such as Clorox (CLX), 3M (MMM) typically have a payout-ratio between 50% and 80%. The percentage is also depending on the sector.
In 2009, several dividend aristocrats did reduce their dividends and were removed from the index. Examples are Anheuser Busch (BUD), Bank of America (BAC), Keycorp (KEY), and Nucor (NUE). In 2012, the dividend aristocrat CenturyLink (CTL) lost also its aristocrat status due to cutting its dividend and showed a pattern similar to Macy’s.
Free cash flow another key metric
On a high-level, the free cash flow (FCF) represents the cash available for the company to repay creditors or pay dividends and interest to investors. This means that when FCF levels decline, it will impact a company’s ability to pay dividends or buy back shares. That’s why several companies announced to halt their buybacks and free-up some FCF to fight the corona-virus impact. AT&T spent 7% of its FCF over the past 12 months and announced to postpone its buyback program. See below Macy’s FCF turning negative and two dividend aristocrats with a sound FCF as an example.
Sustainable dividend growth
The payout ratio, free cash flow (FCF) are good indicators with respect to the sustainability of dividend. Another interesting indicator is the 5 years EPS estimate (forecast) provided by analysts. To be able to keep the payout ratio at the same levels and still grow the dividend every year, requires growth in EPS as well. The table below lists the earnings per share and dividend per share growth of Clorox Company (CLX) over the last years.
The picture shows that the EPS growth is important to have a sound dividend growth, meaning that a dividend growth investor should look for dividend stocks with at least a positive 5 years EPS forecast.
Six dividend aristocrats are at risk to discontinue their dividend streak based on these 5Y-EPS metrics. Three are active in the financial sector.
The performance data shows that 5 out of the 6 are having a difficult time year-to-date. On top, Cincinnati Financial (CINF) has an exceptional high payout-ratio, far beyond the 100%-level.
Furthermore, Archer-Daniels-Midland Co, Franklin Resources, and Genuine Parts are struggling with respect to their FCF.
Other Sources of Dividend Investment Ideas
The Dividend Aristocrats list is not the only way to quickly screen for businesses that regularly pay rising dividends.
- The Dividend Kings List is even more exclusive than the Dividend Aristocrats. It is comprised of less than 20 businesses with 50+ years of consecutive dividend increases.
- The MoneyInvestExpert Defensive Aristocrats is a performance-based top-10 selection of the Dividend Aristocrats to outperform the market on the long-term.
- Portfolio lists like the Berkshire Hathaway Portfolio or Bill Gates’stock portfolio can be a source.
- For the European focused investors there is also the list of European Dividend Aristocrats.
- Dividend Champions are not necessarily members of the S&P 500 index, have increased their dividend for 25 or more consecutive years.
- 100+ years of dividend, the list of stocks that pay over 100 year of dividend can be an list of inspiration.
Next to selecting the right dividend stocks, important principles for successful long-term investing are Disciple, Diversification, Defensive & indeed Dividend. Read more about this in our free e-book.
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