Last week, we started looking for the best dividend stocks and explored how to find them.
We talked about Dividend Pay Out Ratio, Dividend Track Record and Dividend Growth – basically filters to find the best long term dividend stocks that are able to pay dividends from their earnings and have good track record.
However, that is only the first level of filtering, as there are three other MUCH MORE IMPORTANT ASPECTS we need to take into account before we are absolutely certain the dividend companies we found are worth it…
which we will discuss this week.
Most dividends are paid from a company’s cash, so, it is crucial that we understand whether the company is first ABLE TO GENERATE the right cash flow to pay cash dividends.
This is important simply because, if the company is not able to do so, the first three criteria to finding the best dividend stocks, will be rendered moot.
Let’s look at the different types of cash flow a dividend company needs to generate.
1. Cash Flow from Operations
Cash Flow from Operations tells us about a company’s actual cash inflow and outflow – not to be confused with Net Profit, which is recorded on accrual basis.
You see, in the business world, most payments do not happen right away even though transactions are done, and profits have been technically generated,
These transactions may be paid later (aka credit term) and can still be recorded as Net Profit. Therefore, it is important that we ensure the company has incoming Cash Flow, and not just Net Profit that has only been received on paper.
AND this number needs to be positive!
This week, we will be using CLP Holdings (Hong Kong) and YTL Power International (Malaysia) as examples.
Both are electricity companies, which are found under the Utilities sector in WealthPark, and they also have long track records of paying dividends for the past 10 years.
From the screenshots of Cash Flow Ratios above, we can see that both companies have been generating consistent and positive Cash Flow from Operations.
That means, KA-CHING! Both companies passed the first criteria.
2. Free Cash Flow
To ensure continuous business operations, companies sometimes need to reinvest their money back into the business – also known as Capital Expenditure (CAPEX).
A great example would be companies in the airline industry, where hefty amounts are spent to repair, maintain their aircrafts, and also, buying new ones every 5-7 years to replace the old aircrafts. Business models like these are CAPEX-heavy and use a big bulk of their Cash Flow from Operations.
With this in mind, we refer again to the screenshots above to check both companies’ Free Cash Flow.
After deducting their CAPEX, it looks like CLP Holdings is still able to generate positive Free Cash Flow; whereas YTL Power Holdings needs to reinvest their money back to the business, resulting in negative Free Cash Flow for the last 3 years.
3. 5 –Years Average Dividend over Free Cash Flow
If you’re wondering why Free Cash Flow is a criterion, it is simply because companies usually use their Free Cash Flow to pay dividends to their shareholders!
So, by understand that segment, we can determine whether a company is able to consistently and healthily pay dividends.
Let’s now take 5-year Average Dividend and divide it by Free Cash Flow, to find out the amount of dividends the companies are able to pay from their Free Cash Flow.
CLP has been able to pay dividends from their Free Cash Flow with the ratio being less than one. However, as YTL Power has 5 years’ worth negative Free Cash Flow, the ratios turned out to be not meaningful, i.e. their dividends were not paid from their Free Cash Flow as they did not have any.
If by now, you’re thinking, “That is A LOT of numbers to calculate and check!”, fret not, because it’s WealthPark to the rescue!
Profitable investing requires some precision and in-depth research at times, which, let’s face it, AIN’T NOBODY GOT TIME FO’ DAT!
So, we’ve decided to help everyone cut to the chase and put everything into a simple-to-understand chart, called the Star Chart and mapped ALL the criteria we mentioned above and last week, into one assessment point labelled Health.
In fact, you can go to WealthPark now and check the health levels for ALL OTHER COMPANIES you’re vested in.
Starting from next week, we will move on to another type of company, which, if I may say so myself, is a different kind of game altogether – Asset Companies.
So, stay tuned!
P/S: Speaking of dividends, one of the best kinds (not to mention loved by many) of dividend stocks to buy are the REITs because they can yield great passive income for investors.
Click on the button below to get a FREE report detailing some of the best REITs out there.
Disclaimer: All facts and opinions presented are for educational purposes only. This is not a recommendation to buy or to sell. The author(s) involved in the writing of this piece do not have current vested interest of the company. Please consult a competent professional for expert financial, or other assistance or legal advice.