We can get a true picture by looking for consistency. Two simple statistical measures of average and standard deviation can help us measure consistency. A standard deviation that is narrow and lower than average is a good observation. The table below shows some examples of randomly selected financial metric for few companies.

Representative Financial Metric

• SYY is showing consistent performance with narrower standard deviations that are lower than averages.
• WMI has erratic revenue and EPS growth with variations more than averages. Indicating negative performances in past.
• QCOM has wide moat in its market domain and has consistency but its dividend growth is erratic.
• INTC is another example of wide moat in its market domain, with no competitor worth a mention. But its growth in dividends, revenue, and EPS is erratic.

For a given financial metric, when we compare the company’s current performance with historical averages (and standard deviation) is provides some insights into which direction the company is heading into. For example, decreasing operating margins and increasing payout factors are signs of trouble; highly varying metric with many ups and downs is also likely sign of trouble, etc.

I don’t like to get high. Companies that continue to strike balance in their year over year performances are the ones that provide long term sustainable returns.

This post was originally published on The DIV-Net on July 2,  2009.

Waste Management, Inc. provides integrated waste management services in North America. The company is engaged in collection, transfer, recycling, disposal, and waste-to-energy services. WMI is neither a dividend aristocrat nor a dividend achiever. In fact, WMI has started showing some dividend growth trends in last five years. While I am presenting and showing data from last 10 years, I am only using last five years of data. My objective here is to understand if WMI has any potential to be a dividend champion.

Trend Analysis

This section I look at trends for past 10 years of corporation’s revenue and profitability.  The parameters should show consistently growth trends. The trend charts and data summary are shows in images below.

• Revenue: Overall a stable and consistent revenue in last 5 and 10 years. The average revenue growth for last 5 years is 3.2% (with 3.1% standard deviation). While it shows stability, it shows company facing growth challenges.
• Cash Flows: Relatively increasing trend for operating cash flow. The corporation has a consistently higher operating cash flow, two times the net income or free cash flow. The one concern I have is the free cash flow is more or less similar to net income.  What this means is that perhaps, almost all of the corporations net income is being distributed in the form of dividends.
• EPS from continuing operation: In general, the EPS also has an increasing tread since year 2003 with average growth rate as 9.8% (17.5% std dev). Most of that growth is coming in 2004 and 2005. After that is more or less constant.
• Dividend per share: Dividends per share are consistently growing for the last 6 years, including the most recent 2009 dividend increase.

WMI - Trends

WMI Data Summary

Risk Parameter Calculation

Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. I have discussed this in more detail at Dividend Tree. The risk number for risk-to-dividends is 2.14. This is a high risk category as per my 3-point risk scale. The factors that are making it high risk-to-dividends are increasing payout factor, historically high yield, and high variability in EPS.

Quality of Dividends

This section measures the dividend growth rate, duration of growth, consistency over a period of past ten years.

• Dividend growth rate: The average dividend growth (9.6%) is very much similar to average EPS (9.8%) growth rate. However, the EPS has a very high variability (sometimes negative growth). Therefore, there is inconsistency between growth rate of dividend and EPS.
• Duration of dividend growth: Dividends have continuously grown for the last 5 years. Before 1998 in its previous incarnation, before WMI, the corporation has consistency paid dividends for more than 25 years. However, not a consistently growing dividends.
• 4 year rolling dividend growth rate for past ten years: No
• Payout factor: In the recent past 5 years, it has been consistently less than 50%. This provides little flexibility and room to grow dividends.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 4.5%; and (b) MMA yield is 3.4%. Considering the average dividend growth rate of 9.6%, the stocks dividend cash flow at the end of 10 years is 4.5 times MMA income. If we assume my average expected growth rate of 3.2%, then the dividend cash flow is only 1.30 times MMA income.

Fair Value Calculation

This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 20 year DCF: $14.35
• Average high yield price calculated based on past 10 years: $39.8
• Pricing based on past 10 year relative price-to-earnings ratio. $44.0
• Pricing based on price-to-earnings ratio of 12: $26.1
• Graham number: $8.9

The range of fair value is calculated as $17.7 to $25.8. This determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value).

Qualitative Analysis

The strength of WMI business is its well established distribution network and existing market share of approximately 30%. The closest competitor is quite far at half of that market share. Putting this in context of economic environment, it has opportunity to grow due to its pricing ability and leveraging existing distribution network.

• This quantitative analysis shows that, in last 5 years WMI has been able to bring in some level of stability in revenues, profitability, and operating margin. While the corporation is able to maintain consistent operating cash flow, it facing challenges in growing that cash flow. The EPS also has high volatility. Due to its low payout factor, corporation has been able to grow dividends for last 6 years.
• Notwithstanding the stable operating cash flow, the recession driven slow down is likely to affect its EPS. The corporation has already acknowledged the adverse effect of (1) reduction in commodity prices; and (2) slow down in residential business sector which is one third of its revenue.
• Assuming that the corporation’s existing trends in profitability and growth continue ‘as is’, I expect dividend growth to slow down relative to its historical growth.

Conclusion

The Company raised its annual dividend for 2009 from $1.08 to $1.16 per share. This increase shows corporation’s confidence in its operating cash flow. For 2009, I believe this increase is ably supported by the stable operating cash flow. However, the stocks risk-to-dividend number is 2.14 (high risk category). In addition, the dividend cash flow is also 1.30 times the MMA income based my expected dividend growth of 3.2%. At current pricing of $25.47, the risk/return characteristics does not justify starting a new position. The risk/return characteristics become favorable at the price of $16.50 at which the MMA income is more than 3 times the MMA income.

Investors looking for value plus sustainable current dividends (and not necessarily dividend growth) will find WMI attractive.

Full Disclosure: No position at the time of this writing.

History shows that it is normal for corporations to change (increase, decrease, or suspend) the dividends paid to the common share holders. These changes take place irrespective of which stage of economic cycle we are in. In last one year, i.e. between March 2008 and February 2009, within S&P500 index, there were 205 corporations that increased their dividends, 63, have decreased their dividends, and 25 have suspended their dividends. I could be argued that all 205 may not have good quality sustainable dividends. However, this list is deep enough for mining potential gems. In general, a typically dividend growth investor will look for a corporation that has increase its dividend consistently for at least last 10 years. It is always good to wait for 10 years worth of dividend history. However, I would like to evaluate corporations that have started showing signs of dividend growth early on, and see how it stands in my analysis.

In this context, I have shortlisted nine corporations (from S&P500) that for the last five years have (1) consistently increased their dividends; and/or (2) demonstrated their inclination to consistently pay dividends. The attached table shows the dividends for last 5 years and corresponding growth in last five years. Note: Year 2003 growth is with respect to Year 2002.

S&P500 Potential Dividend Growth Opportunities

Waste Management, Inc. (WMI): It provides integrated waste management services in North America. The company offers collection, transfer, recycling, disposal, and waste-to-energy services.

• Pros: Stable cash flow, dominant market share, per management no planned large capital expenditure in near future, more than 100 year old corporation, stable industry
• Cons: lack of revenue growth

T. Rowe Price Group, Inc. (TROW): It is a publicly owned corporation, a holding group, and an investment manager. The firm provides its services to corporations, corporate, public, and Taft-Hartley retirement plans, foundations, and endowments.

• Pros: Debt free, likely beneficiary of baby boomer driven demographic shift, no direct impact from current financial turmoil, only an investment manager, stable industry
• Cons: recession driven slowing down

Analog Devices, Inc. (ADI): It engages in the design, manufacture, and marketing of analog, mixed-signal, and digital signal processing integrated circuits (i.e primarily high performance analog chips) used in industrial, communication, computer, and consumer applications.

• Pros: dominant market share in key product segments, products sell that 55%+ gross margin, debt free, positive cash flow
• Cons: lack of revenue growth, cyclic industry

Linear Technology Corp. (LLTC): It designs, manufactures, and markets various linear integrated circuits (i.e. high performance analog chips, linear products)

• Pros: dominant market share in key product segments, products sell that 65%+ gross margin, positive cash flow
• Cons: lack of revenue growth, cyclic industry

Qualcomm (QCOM): It manufactures and markets digital wireless telecommunications products and services based on its code division multiple access (CDMA) technology and other wireless communication technologies.

• Pros: Ownership of CDMA technology, high royalty revenue (approx. USD 1 billion), all competitor in its market segment operating at loss, technological leadership in communication market,
• Cons: cyclic industry, engaged in too many legal battles,

Intel Corporation (INTC): It designs, manufactures, and sells integrated circuits for computing and communications industries worldwide. It is the manufacture of microprocessor products used in desktops, nettops, workstations, servers, embedded products, communications products, notebooks, netbooks, mobile Internet devices, and consumer electronics.

• Pros: lone player, no long-term viable competitor, technological leadership
• Cons: cyclic industry, history of squandering cash flow in acquisitions,

CME Group Inc. (CME): It operates two self-regulatory futures exchanges viz. CME and CBOT. The company offers an array of products available across various asset classes, including futures and options on futures based on interest rates, equity indexes, foreign exchange, agricultural commodities, and alternative investments, such as weather and real estate.

• Pros: futures exchange,
• Cons: recession driven slow down in volume

Campbell Soup Company (CPB): This firm together with its subsidiaries engages in the manufacture and marketing of branded convenience food products worldwide. It operates in four segments: U.S. Soup, Sauces, and Beverages; Baking and Snacking; International Soup, Sauces, and Beverages; and North America food service.

• Pros: staples industry, distribution network advantage during recession.
• Cons: prolonged recession affecting revenue, shift to non-branded products, slow dividend growth

Becton, Dickinson and Company (BDX): It is a medical technology company that develops, manufactures, and sells medical supplies, devices, laboratory equipment, and diagnostic products worldwide.

• · Pros: likely beneficiary of baby boomer driven demographic shift, signs of dividend friendliness,
• · Cons: low dividend yield

These are nine corporations that provide a good starting point for additional research. Some the key areas that need further analysis are factors such as cash flow, income, debt level, growth in earnings, and future growth potential. In addition, one another aspect that would need close attention is to understand management’s policy or philosophy vis-à-vis dividends for common share holders. I would like to invest in at least two corporations which have low-to-moderate risk to dividends. I will provide updates as I move forward with the research.