A photograph captures a moment in time. Seconds after the flash dims a tree could have fallen on the object of the photo or the sad looking man in the photo could have been told he just won a million dollars. In much the same way a dividend stock analysis is a snapshot in time, but the real question for the savvy dividend investor is ‘where is the stock headed?' Here are four important directional metrics that I look for when updating my stock database…
1. Declining Shares
Many companies sell stock to raise cash. The important question is what is the company going to do with the cash? Is it for an acquisition or "general corporate purposes?" The latter is code for the business is not generating enough cash to stay afloat on its own. I am wary of a company that consistently has more shares outstanding in the current year when compared to the prior year. As I enter updates to my database, equal or lower shares outstanding is a sign of a healthy business.
2. Declining Debt
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When companies need to raise cash and selling shares is not a good option, they often will issue debt. Once again, the important question is what is the company going to do with the cash? Like issuing shares, debt for a strategic acquisition is much more palatable than for "general corporate purposes." I am wary of a company that consistently has more debt outstanding than the year before. As I enter updates to my database, I make note of companies with a declining debt balance and see that as a sign of a healthy business.
3. Rising Equity
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Changes in shareholder's equity are a result of earnings, dividends paid, treasury stock purchased, stock options exercised and stock issued. If shares outstanding aren't increasing, and equity is rising then the business is generating sufficient earnings to cover dividends and share repurchases. Increasing the value of the company by running the business well is a sign of a healthy company.
4. Rising Free Cash Flow/Share
Ultimately, we want our investments to generate more free cash flow so they can pay us higher dividends. Free cash flow is an important metric in that it excludes cash generated from issuing stock or issuing debt or selling off parts of the business. Free cash flow is limited to only the cash generated from running the business.
Dividend Stocks Headed In The Right Direction
Combining the equity and debt metrics, I looked for companies with a declining Debt to Total Capital ratio, and combining the free cash flow and shares outstanding metrics, I looked for a rising free cash flow per share. Below are several companies I noted that exhibited each of the above characteristics:
Automatic Data Processing Inc.