Recently, we saw the ugly side of debt. As we all watched Kinder Morgan’s stock fall and wait for the final, inevitable sword of a dividend increase, there was one thing that became evident…KMI’s debt level was too high and the results were unsustainable in the current market environment (See Lanny’s awesome write up/analysis about KMI from earlier in the week). The pressures mounted and management plus the Board of Directors decided to slash their dividend to preserve cash flow for capital expenditures and cover interest/dividend payments. While debt isn’t a bad thing, I don’t want you leaving this intro thinking that’s my conclusion, runaway/uncontrolled debt can present many problems. The name of our game on this website is investing in stocks with a growing dividend income stream, so we try to avoid companies and stocks that take us off of this course. Which is very ironic considering that Lanny and I purchased shares in KMI just under a month ago (here and here) With the wound from KMI still fresh, I wanted to run a stock screener and identify several Dividend Aristocrats with low debt levels. Check out our newest installment of our Top 5 list series (foundation stocks and low dividend yield/high dividend growth rate stocks)….the Top 5 Dividend Aristocrats with Low Debt to Equity Levels.
About the Debt to Equity Ratio
Before I dive any further into the screener that I ran this morning, let’s take a quick look and get to know the debt to equity level. The equation is as simple as the name sounds, the debt to equity metric analyzes a company’s total debt owned compare to the company’s equity. A debt to equity ratio greater than 1X means that the company has more debt/financing from borrowers than shareholders and vice versa. This is a quick metric that can show you the structure of the balance sheet and help us identify if a company’s debt load has suddenly grown recently, which could trigger further analysis by you to determine if you believe the debt load is sustainable give the company’s current dividend, expected cash flows, ability to cover interest, etc.
I must say, if you leave this article thinking debt is a terrible thing and company’s should avoid using debt to fund/finance operations, then I have performed a disservice. In fact, there are many companies that operate in industries that high debt levels are the norm and debt is the engine that keeps the company rolling (such as Realty Income or other REITs). Debt is a great tool for companies and can often be a cheaper source of capital than raising cash through the equity market because of the tax benefits and the current low-cost of capital in the marketplace. Companies have been adding to their debt load while interest rates remain at low (at least for the time being) to avoid having to lock in debt at a higher interest rate in the future. Many companies have used debt to fund their dividend, share buyback programs, dividend increases, acquisitions, or other operational projects and it has turned out very well for shareholders. As with everything, debt is great as long as it is managed properly and controlled. Running a quick Debt to Equity analysis for a company’s recent history will help you identify whether a company consistently maintains a certain debt level or if the company has been taking on a lot of debt over the few years, prompting the “Is it safe” question that I should have asked myself as I watched KMI continue to grow its dividend, make moves, and increase their debt outstanding.
The Screener
I was determined to find a listing of companies with low debt to equity ratios in light of recent events. This may be extreme given that debt is not always a bad thing. However, I don’t mind going jumping to the complete other end of the spectrum as long as I am investing in a great company. To develop our listing of Dividend Aristocrats with low debt to equity ratios, I used the following metrics. My focus was less on current pricing multiples such as P/E ratio (The first step in our stock screener), so I have left this metric out for the purposes of our stock screener. Here were the filters I ran this morning.
- The Company is a Dividend Aristocrat – One of the other side effects of a company slashing its dividend is that I am really getting tired of seeing my dividend income head in the wrong direction. We do our best to identify great companies, but as we all know (and sometimes forget), a dividend is not guaranteed, let alone a dividend increase. The year is full of surprises and one of the interesting nuggets has been that some of the large companies that have experienced high dividend increases in recent history suddenly announced lower than usual increases, a product of the current economic environment I am sure. Investing in Dividend Aristocrats, which may be boring to many outside of our community, puts us in the best position to receive increases annually because their management team has demonstrated their commitment and ability to deliver a growing dividend income stream over a long period of time. Considering I am coming off of a dividend cut for the third time in two years, investing in a company with over 25+ years of consecutive dividend increases would be welcomed.
- Debt to Equity Ratio of .5X or Less – I mentioned that I was being extreme here, but I wanted to find the Dividend Aristocrats with the LOWEST debt ratios possible for the purposes of this listing. Shockingly there were a lot more companies than I expected that met this ratio!
- Current Ratio Over 1– In short, this is another variation of a debt metric. Current ratio compares a companies current assets to current liabilities. If the ratio is greater than 1, current assets exceeds current liabilities. I like this metric because it demonstrates that in a company can pay off their current debt in a true crunch without having to take on long-term debt or reduce their outflows (which could include their dividend)
- Payout Ratio Under 60% – One of our three metrics in our stock screener, we believe a 60% payout ratio or less is the sweet spot for companies. Once payout starts to creep towards 100%, then we have to start worrying about the dividend safety as a company cannot sustain paying out over 100% of its earnings for an extended period of time. 60% provides a nice cushion and after all, I don’t want to review stocks with low debt for the sake of finding companies with low debt if they do not have a sustainable dividend.
The Results
The anticipation has been mounting, I know. I’m sure you all are sick of hearing me talk and just want to know the freaking results! Below are our Top 5 Dividend Aristocrats with a Low Debt to Equity Ratio……drumroll please!
- Archer-Danieals Midland (ADM) – Debt to Equity = .38X – Talk about timing, Lanny just purchased this stock last week and had no clue that ADM was going to be included on this list…foreshadowing maybe? ADM has been one of my favorite companies since I performed a stock analysis and initiated a position earlier in the year. I’m still shocked I haven’t added more…honestly. ADM has increased their dividend for 39 consecutive periods and is now yielding ~3.2%. Even better, their 3 year average dividend growth rate is 17.18%!
- Abbott Labs (ABT) – Debt to Equity = .37X – Neither of us hold a position in this stock or have actively included it on our watch lists, most likely because of this medical company’s lower dividend yield of 2.16%. However, ABT has increased their dividend for 42 consecutive years and just announced a fresh 8.4% dividend increase. Maybe I’ll have to start keeping an eye on this company after all!
- Genuine Parts Company (GPC) – Debt to Equity = .2X- Another stock that I performed a stock analysis over earlier in the year. I love many aspects about the company, the fact the company dominates the industry in which it operates, the secondary auto part market (which has been on my radar over the last few weeks given my recent fender bender), and their history of increasing their dividend. They were just too expensive at the time of the analysis, so I passed. GPC has increased their dividend for 58 consecutive years and has a 3 year average dividend growth rate of 7.5%.
- Hormel Foods Company (HRL) – Debt to Equity = .11X – Similar to ABT above, Hormel has typically been off of our radar because of the low dividend yield, which is currently 1.5%. In addition, it didn’t make the cut for Lanny’s listing of Top 5 low dividend yield, high dividend growth rate stocks. But that doesn’t mean it shouldn’t be considered by investors seeking companies with a low debt level. HRL has increased their dividend for 48 consecutive years and is one of those consumer good companies that can be found in nearly everyone’s household. Those are the company’s that I LOVE to include in my portfolio.
- Johnson & Johnson (JNJ) – Debt to Equity = .28X – Man, how is it possible that JNJ always finds a way onto lists focused on finding great dividend stocks! This company is amazing and has increased their dividend for 52 consecutive years. I don’t need to say too much more about this stock, other than there is a reason we consider it one of our foundation stocks for a dividend portfolio and that I have included this stock on my list of five “Always Buy” companies. This company truly continues to amaze me.
What are your thoughts on the listing? How many of the stocks do you own? What impact does debt or the debt to equity ratio play in your decision-making process? Do you have a threshold? If so, what is it? Is .5X way too small of a ratio in your opinion? Please let me know your thoughts on this analysis and stock screener!
Bert