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New York, Jul.18, top stocks .- In the comments section of last week's Safety Net column, Andy posted:
"Your Book, Get Rich With Dividends... and related Wealthy Retirement letters, are excellent. I follow them closely.
"What is your opinion of Wisconsin Energy Corp. (NYSE: WEC) and its dividend safety? From Dividata, the dividend is increasing consistently from year-to-year."
Wisconsin Energy Corp. (NYSE: WEC) is a Milwaukee-based electric and natural gas utility serving over 1 million customers in Wisconsin and the upper peninsula of Michigan.
It has raised the dividend for 10 straight years at an average annual growth rate of over 11%. That's pretty strong for an electric utility.
Last year it paid out $276 million in dividends against $546 million in profits - for a payout ratio of 51%. Not bad at all.
However, if you've followed my work for a while, you know that I don't give profits much credence when looking at dividend safety. That may sound crazy, but hear me out.
Cash Is King
Profits, or net income, can be easily manipulated and include all kinds of non-cash items like depreciation, amortization, stock-based compensation, etc.
When I'm looking at dividend safety, all I care about is cash.
How much cash does the company bring in and how much does it pay back to shareholders? I don't care about profits. Dividends aren't paid out of net income. They're paid out of cash flow.
There are several ways of looking at cash flow. Cash flow from operations is how much cash the company generates from running its business (as opposed to financing, investing, etc.). Free cash flow is the most conservative as it takes capital expenditures into account.
The formula for free cash flow is cash flow from operations minus capital expenditures. And that's what I use most of the time to determine the dividend safety. It doesn't matter what the profits are if the company isn't generating enough cash to pay the dividend.
75% or Less...
In Wisconsin Energy's situation, the payout ratio based on free cash flow is 59.6%. That's well below my 75% threshold for most stocks. Generally speaking, I like to see a company paying out 75% or less of its free cash flow in the form of dividends. That way if the company hits a rough patch and free cash flow declines, the dividend won't be in jeopardy.
In 2010 and 2011, the company actually paid out more in dividends than it was generating in free cash flow - even though it raised the dividend every year. That would have concerned me greatly.
But that was then and this is now. In 2012, the payout ratio was in safe territory. And it looked even better in the first quarter of 2013 when Wisconsin Energy generated over $177 million in free cash flow and paid just under $78 million in dividends, for a payout ratio of just 44%.
The state of Wisconsin is in pretty good shape, with a budget surplus and a population that has grown 2% since 2007. That compares to 1.4% growth in Illinois and a 1.1% decline in Michigan.
With more customers moving to the Badger State, free cash flow expected to grow over 25% next year and a solid track record of raising dividends, I expect Wisconsin Energy to continue to light up (see what I did there?) investors' income portfolios for years to come.
Dividend Safety Rating: A
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