Dividend growth strategies are very popular among advisors, and it is essential that advisors find opportunities that will reward their clients in the future.
However, there are some recurring misconceptions surrounding dividend growth investing. For example, it’s not the number of years a company has paid a dividend that matters. Rather, it’s the cash flow that makes the dividend payment possible that really matters.
Free cash flow — the remaining cash a company has after accounting for operating expenses and capital expenditures — is one of the best indicators of a company’s dividend-paying ability, according to VictoryShares & Solutions.
Many advisors consider a company’s dividend history when identifying a ripe investment opportunity. However, it’s a common misconception that all companies with a track record of growing their dividends will continue to do so.
“While a company can use some gimmicks to support earnings, free cash flow is a cleaner way to measure financial health,” said Todd Rosenbluth, head of research at VettaFi. “Companies with strong and growing free cash flow have the ability to not only support but raise dividends annually.”
Dividend Growth Can’t Continue Without Ample Free Cash Flow
General Electric (GE) is an example of a company with a long track record of growing its dividend. But it abruptly became a big dividend cutter in the last decade. After growing its dividend for decades, GE suddenly had no free cash flow and had to slash its dividend.
GE exemplifies how past dividend history isn’t a surefire way to predict future dividend growth. Instead, current and expected free cash flow can better indicate a company’s dividend-paying ability.
Ultimately, dividends are paid from free cash flow. Companies cannot sustainably pay and grow dividends without generating healthy free cash flow.
For more news, information, and analysis, visit the Free Cash Flow Channel.
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