Too often, dividend investors just assume that companies have the cash flows needed pay their dividends.
Did you know:
- companies can grow their reported earnings while cash flows are negative.
- most companies overstate their reported earnings.
- lots of companies have to borrow money, issue stock, or dip into cash reserves to pay dividends.
The only way to know that a company can afford to pay its dividends is to measure its free cash flow (FCF). FCF must be equal to or greater than its dividend; otherwise, the company must raise capital or use cash reserves to pay its dividend. Or…the company has to suspend or cut its dividend.
In other words, FCF is important. There is no good excuse for not doing the diligence on FCF to be sure a company’s dividend is safe.
As my regular readers know, my firm’s research gives you the best insight into the safety of dividends. For example, in Figure 2 below, I directly compare the featured stock’s cash dividend payments to its free cash flow.
Today’s free stock pick provides a summary of how I pick stocks for the Safest Dividend Yields Model Portfolio. This summary is not a full Long Idea report, but it gives you insight into the rigor of my firm’s research and approach to picking stocks.
This Model Portfolio only includes stocks that earn an Attractive or Very Attractive rating, have positive free cash flow (FCF) and economic earnings, and offer a dividend yield greater than 3%. Companies with strong free cash flow provide higher quality and safer dividend yields because strong FCF supports the dividend.
Stock Feature for January: Dine Brands Global Inc. (DIN)
Dine Brands Global Inc. (DIN) is the featured stock in January’s Safest Dividend Yields Model Portfolio.
Dine Brands has grown revenue and net operating profit after tax (NOPAT) by 1% and 2% compounded annually, respectively, since 2018. The company’s NOPAT margin improved from 19% in 2018 to 20% in the TTM, while invested capital turns rose from 0.3 to 0.4 over the same time. Rising NOPAT margins and invested capital turns drive the company’s return on invested capital (ROIC) from 6% in 2018 to 7% in the TTM.
Figure 1: Dine Brands’ Revenue & NOPAT Since 2018
Free Cash Flow Exceeds Regular Dividend Payments
Dine Brands has increased its regular dividend from $0.40/share in 4Q21 to $0.51/share in 4Q24. The current quarterly dividend, when annualized provides a 7.0% dividend yield.
The company’s free cash flow (FCF) easily exceeds its regular dividend payments. From 2019 through 3Q24, the company generated $1.3 billion (64% of current enterprise value) in FCF while paying $253 million in regular dividends. See Figure 2.
Figure 2: Dine Brands’ FCF Vs. Regular Dividends Since 2018
As Figure 2 shows, this company’s dividends are backed by a history of reliable cash flows. Dividends from companies with low or negative FCF are less dependable since the company would not be able to sustain paying dividends.
DIN Is Undervalued
At its current price of $29/share, this stock has a price-to-economic book value (PEBV) ratio of 0.4. This ratio means the market expects the company’s NOPAT to permanently fall 60% from TTM levels. This expectation seems overly pessimistic given that the company has grown NOPAT 2% compounded annually over the last five years and 5% compounded annually over the past two decades.
Even if the company’s:
- NOPAT margin falls to 14% (the lowest margin in the last five years and below TTM margin of 20%) and
- revenue grows at consensus rates in 2024 (-2%), 2025 (1%), and continues to grow at 2025 consensus rate (1%) each year thereafter through 2033,
the stock would be worth $35/share today – a 21% upside. In this scenario, the company’s NOPAT would fall 3% compounded annually through 2033.
Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.
Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology
Below are specifics on the adjustments I make based on Robo-Analyst findings in this featured stock’s 10-K and 10-Qs:
Income Statement: I made over $120 million in adjustments with a net effect of removing over $70 million in non-operating expenses.
Balance Sheet: I made around $1.2 billion in adjustments to calculate invested capital with a net increase of just under $900 million. The most notable adjustment was for asset write downs.
Valuation: I made just under $1.9 billion in adjustments to shareholder value, with a net decrease of around $1.6 billion. Other than total debt, the most notable adjustment to shareholder value was for excess cash.
Disclosure: David Trainer, Kyle Guske II, and Hakan Salt receive no compensation to write about any specific stock, style, or theme.
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