by Sridharan Raman.
With all the news surrounding the strained energy companies and possibly endangered dividends, we took a look at the other end of the spectrum. We scanned for companies that pay a healthy dividend and are likely to sustain those dividends in this low interest rate environment. Such companies do exist!
What characteristics define them? They must have stable balance sheets that aren’t overly levered. They must have strong earnings quality, including strong free cash flows. It helps if analysts aren’t too bearish on their earnings prospects. Finally, we wanted to look at companies that are not overvalued or have negative price momentum. After all, if a company pays a hefty dividend, but its stock price declines, the stock may not be as attractive. Let’s fire up our Eikon Screener.
As you can see above, as we increased the screening criteria, the number of companies coming through the screens decreased dramatically. Of the 2,216 companies that have market cap greater than $1 billion, only 419 have a dividend yield of greater than 3%, of which only 50 score in the top quintile of our Earnings Quality model. This model takes a look at the sources of earnings and higher scores indicate earnings that are coming from sustainable sources.
We then eliminated companies that scored poorly on our Combined Credit Risk model to ensure that we only captured companies with strong balance sheets. We then looked at companies that scored well on the Analyst Revisions Model. This indicates that analysts are bullish on future earnings.
Finally, we wanted to ensure the company is generating positive free cash flows, which is a sign that the company is likely to sustain, if not raise, dividends in the future. As you can see, only eight companies satisfy all these criteria. If we then eliminate those companies with poor price momentum and score poorly on our Relative Valuation model, we are left with just three companies.
Fundamentals and trends
CME Group, Dow Chemicals and Philip Morris are companies with strong fundamentals. CME did pay special dividends in the last year, and has adopted an annual variable dividend structure for the excess cash held at the end of the year. Expect another strong dividend this year as the cash on the balance sheet looks strong again.
Phillip Morris is seeing good demand for cigarettes and enjoying healthy margins as its business looks stronger than ever. Dow Chemical is benefiting from demand for its chemicals and is expected to continue to see margin expansion and synergies take effect from its DuPont merger — good news for future dividends.
If you are looking for strong dividend payers, these companies may be worth a second look. We have set a very strict set of criteria; by loosening some of the restrictions, you could unearth other strong dividend candidates.