Dividend growth investing is a popular and largely successful approach to generating wealth over long periods of time. Investors typically do well focusing on companies with long streaks of dividend increases in part because of the positive qualities a business needs in order to be able to continually afford what is ultimately a cash layout to shareholders. However, many of the companies known as "dividend champions" - those with 25 consecutive years (or more) of dividend growth, are mature companies. By identifying strong companies earlier in their life cycle, we can benefit from strong total returns while these companies build their dividend growth reputation. We will be spotlighting numerous dividend up and comers to identify the best "dividend growth stocks of tomorrow".
Today's profile is on Agilent Technologies, Inc. (A). Founded in 1999 following a spin off from Hewlett Packard (HPE), the company designs and builds a variety of instrumentation and solutions used for analysis in a handful of core end markets, including petro-chem, environmental, food, pharma, academia, and clinical. In all, Agilent generates approximately $5 billion in annual revenues.
Source: Agilent Technologies, Inc.
The landscape at Agilent Technologies has been a bit uneven over the years. The company split into two separate companies a few years ago, the other currently trading as Keysight Technologies (KEYS). This split shows up in the company's chart in the form of a large drop off. Over the past three years, Agilent has grown its top line at a CAGR of 6.76%. EPS growth has been negative, but we can see that EBITDA has steadily grown with revenues, almost tripling.
Fundamentals are the building block of any responsible investing decision. By tracking key operating metrics over a long period of time, we can learn a lot about a business.
We review operating margins to make sure the company is consistently profitable. We also want to invest in companies with strong cash flow streams, so we look at the conversion rate of revenue to free cash flow. Lastly, we want to see that management is effectively deploying the company's financial resources, so we review the cash rate of return on invested capital (CROCI). We will do all of these using three benchmarks:
We see a couple of themes present from over much of the past decade. First, we see how much of a disruption occurred when the company split into two entities. All three metrics crashed over a two-year period. The good thing, however, is that the metrics have recovered strongly after bottoming in 2015. Currently, all three metrics surpass our benchmarks. Investors interested in Agilent Technologies will want to see the company maintain this level of performance moving forward.
The other aspect of our fundamental analysis is the balance sheet. The balance sheet is so important because it can turn an otherwise great business into a poor investment if a company has too much debt on its books. A company that is overleveraged could be subject to a dividend cut or cash flow crunch that takes away from the company's ability to perform at its highest potential.
The company is in strong financial standing with almost no net-debt load once you factor in the company's $1.7 billion cash balance. The gross debt load puts leverage at 1.47X EBITDA, which is still below our 2.5X cautionary threshold. This gives the company financial flexibility to pursue growth via M&A, and insulates shareholders from risk should the business face an unexpected downturn.
The reason we value companies with the ability to generate large cash streams is that these companies tend to return that cash to investors. Dividends and buybacks can boost total returns in a number of ways. Agilent Technologies has increased its dividend payout for each of the past 8 years. This means that management has kept this dividend growth philosophy through its split with Keysight.
The dividend currently amounts to an annual sum of $0.66 per share, which yields 0.87% on the current share price. This means that despite a low interest rate environment that sees 10-year US treasuries yielding just 1.73%, Agilent Technologies isn't a great income generation stock at this point. Investors looking for growth will be more optimistic. The dividend has grown at a CAGR of 12.6% over the past five years. The company's cash payout ratio of 22% means that there is plenty of room for future dividend growth.
This article was written by Wealth Insights. A well-known investment author on Seeking Alpha with over 6,000 followers.
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