If we can establish that a stock's current dividend is sustainable long term, we can take the stock's current yield and, voila, one chunk of our total return is accounted for. Taking a dividend for granted means establishing long-term sustainability. Nothing lasts forever--just ask the shareholders of once-venerable Goodyear Tire GT--although a few stocks, such as General Electric GE, have dividend records that come awfully close to immortality.
What establishes a secure dividend? Look for manageable debt levels. Remember, bondholders and banks are ahead of stockholders in the pay line. Next look for a reasonable payout ratio, or dividends as a percentage of profits. A payout ratio less than 80% is a good rule of thumb. Finally, look for steady cash flows. Also demand an economic moat: No-moat companies tend to be cyclical (think autos and chemicals) and lack the pricing power to maintain earnings during the inevitable industry downturns.
Coca-Cola KO is a good example. In mid-2005, the shares were changing hands at about $45 while paying a $1.10 annual dividend. At that time, the payout ratio was reasonable (52% over the previous 12 months), cash actually exceeded debt (no debt worries), and operating cash flows were consistent. Best of all, the firm's moat is very wide--Coke is arguably the most valuable brand name on earth, quite the achievement for what is, after all, caramel-colored sugar water.
Coke's yield at that point was 2.4% ($1.10 / $45), giving us the first building block of prospective total return. And based on current earnings power of roughly $2.00 per share, we'll have $0.90 in retained earnings to fund dividend growth, which, as noted earlier, takes two forms.
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