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Dividend Post

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THE THREE MOST IMPORTANT NUMBERS

FOR DIVIDEND GROWTH

1) Net Income

2) Depreciation and Amortization

3) Capital Expenditures


Dividend To Cash Flow Ratio

I like to refer to this as the DTCF Ratio

Accounting rules require companies to disclose their financial statements and the three numbers that
interest dividend investors (according to me would be as follows:

Net income (or alternatively Net Income Per Share) is equal to all revenues minus all expenses

Depreciation and Amortization

Capital Expenditures

Now for a “very brief” explanation:

Depreciation and Amortization is an expense category:

This expense category of is a non cash expense. Companies depreciate assets much like
the car you recently purchased. Over time, the assets a company collects lose their vale.
The accountants call this depreciation, which really means the assets are “used” and getting older over time.
They deduct and amount every year from the revenues to reflect this depreciation, however the company does
not disburse any cash for this accounting entry. It is simply that………… an accounting entry.

Capital Expenditures - another fancy term in accounting parlance to explain new assets a company must purchase
to either replace the used stuff, or keep up with new technologies. In simple terms, when your car gets old, you buy a new one.
This is a capital expenditure in accounting terms. Capital expenditures are cash disbursements and can be VERY BIG
in certain companies.

Here are two simple examples:

Company WE SPEND CASH INC. in year 1:

Net Income in year 1= $ 0.90
Depreciation in year 1 = $ 0.50

Total cash flow available to shareholders n year 1: $ 1.40

Capital expenditures in year 1: $ 0.55

Cash Flow available for shareholders: $ 0.90 + $ 0.50 - $ 0.55 = $ 0.85

Dividend: $ 0.10

Dividend / Cash Flow

$ 0.10 / $ 0.85 = 15 percent

15 percent of the cash flow is used to pay dividends.

Company “WE SAVE CASH INC.” in year 1:

Net Income in year 1= $ 0.90
Depreciation in year 1 = $ 0.50

Total cash flow available to shareholders: $ 1.40

Capital expenditures in year 1: $ 0.40

Cash Flow available for shareholders in year 1: $ 0.90 + $ .50 - $ 0.40 = $ 1.00

Dividend / Cash Flow

Dividend: $ .10

$ 0.10 / $ 1.00 = 10 percent

In this case, company XYZ is paying out 10 percent of their cash flow as dividends.

On the surface it would appear that 15 percent is better than 10 percent, but in this case,
that is not true. And the reason is very simple…… Company We Need Cash Inc. requires more money
to fund capital expenditures than company WE SAVE CASH INC. Company WE SAVE CASH INC. earns the same as company
WE SPEND CASH INC., but requires less capital. The result is that company WE SAVE CASH INC. will have an easier time
paying dividends, and an easier time “INCREASING” dividends, over time.

Let’s assume both shares trade for $ 2.00 per share.
The Dividend Yield for both companies = $ 0.10 / $ 2.00 = 5 %
Consider the yield of 5% as the equivalent of an interest payment.

OVER TIME the company that can keep their dividend to cash flow ratio, as described above,
consistent or “LOWER”, the better chance shareholders (you) will have receiving an ever increasing
dividend. In the case above an ever increasing dividend is crucial. If your initial yield is 5%, and the dividend
is increased in year 2 to perhaps $ 0.11, then your yield suddenly becomes 5.5% ($ 0.11 / $ 2.00).
OVER TIME, an ever increasing dividend increases your yield….. this is powerful income growth. Your
dividend checks (or in most cases - automatic deposits) just keep growing and growing.

A second interesting thing happens: Companies that have the ability to keep the DTCF ratio in check will
more than likely be capable of increasing their long term earnings, end hence provide shareholders with
capital gains (increased share price). OVER TIME, company WE SPEND CASH INC. will be worth less than company
WE SAVE CASH INC., all other things being equal.

WE SPEND CASH INC. will generate more cash, pay ever increasing dividends, and also have more capital
available to reinvest in the growth of the business.

OUR RATINGS CATEGORY

TIER 1: DTCF is historically decreasing over time while the dividends paid keeps increasing each year.

TIER 2: DTCF is historically constant over time dividends paid keeps increasing each year.

TIER 3: DTCF is historically increasing over time but dividends keep increasing each year.

TIER 4: DTCF is historically increasing over time but dividends keep constant each year.

TIER 5: DTCF is historically increasing over time and dividends falling.

TIER 1 and TIER 2 Ratings will generally offer the best opportunities to keep a growing dividend
as well as share appreciation. TIER 3 companies will require careful monitoring, however companies
with a strong franchise in TIER 3 would still be considered.

TIERS 4 & 5 are probably worth staying away from as the dividend could be at risk.

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