2 Dividend Kings For A Comfortable Retirement (2024)

By Valuentum Analysts

In common nomenclature for dividend growth investors, a Dividend King is a company that has raised its dividend in each year for the past 50+ years. If you think about what a firm has had to endure to keep raising its payout each year over a half century, the label is quite impressive. Not only have these companies endured savings & loan crises, the dot-com bust, wars, the Great Financial Crisis, and COVID-19 meltdown, but they have thrived over this time period to keep raising the payouts through thick and thin.

With this said, it's important that investors understand what a dividend is and what it isn't. When the dividend is paid, the stock price is reduced by the amount of the dividend, so investors should not become too enamored by the payout. Don't let the dividend tail wag the total return dog, as we often say. As an investor, you already own all the assets of a firm, and that includes the cash on the balance sheet before it pays the dividend. When a company pays a dividend, its intrinsic value is reduced by the amount of the dividend, too, and the company's share price is reduced by the amount of the payout as well.

We recently wrote about two Dividend Aristocrats that we thought investors should avoid in this article, "2 Dividend Aristocrats to Avoid," and they were Walgreens (WBA) and Air Products (APD). Walgreens has since cut its payout. Our focus when it comes to dividend payers rests on whether traditional free cash flow, as measured by cash flow from operations less all capital spending, is expected to continue to outpace cash dividends paid. We also pay close attention to the firm's balance sheet, as net cash on the balance sheet offers the company financial flexibility to keep paying its dividend if operations hit a speed bump in any given year through the course of the economic cycle.

As we look at the following two Dividend Kings as it pertains to this article, we think a focus on 1) their revenue growth prospects, 2) their free cash flow coverage of the payout, and 3) the health of their balance sheets remains key. We want to see strong organic revenue growth, solid free cash flow coverage of the dividend, as well as investment-grade credit ratings or a strong net cash position on the books. If these three criteria are positive, we'd generally view the future dividend growth potential of a company as positive. The higher the Dividend Cushion ratio above 1, the stronger the dividend health.

Procter & Gamble (PG)

Very few companies have the history of Procter & Gamble, with its operations dating all the way back to 1837 in Cincinnati. The company's major brands include Head & Shoulders, Herbal Essences, Braun, Gillette, Crest, Oral-B, Ariel, Downy, Luvs and many others. The company has increased its dividend for the past 67 consecutive years and has been paying a dividend 133 consecutive years since its incorporation in the late 19th century.

Let's talk growth. During fiscal 2023, the company's organic sales grew 7%, marking the fifth consecutive year of material positive organic sales growth expansion (5%+). Importantly, more recently, all ten of its key product categories have been experiencing positive organic sales expansion led by Personal Health Care and Feminine Care. Total revenue growth is expected to expand 3.5% in fiscal 2024 and 4% in fiscal 2025 based on consensus numbers.

For the three months ended September 30, 2023, P&G's cash flow from operations expanded to $4.9 billion from $4.1 billion, while capital expenditures grew to $925 million from $890 million. Free cash flow came in at ~$4 billion in its first fiscal quarter of 2024, significantly higher than what it paid out as dividends (~$2.3 billion). Its long-term credit ratings are investment grade at Aa3 (Moody's) and AA- (S&P) with a stable outlook.

On the basis of our discounted cash flow process, we value shares of P&G at $167 per share, higher than where shares are currently trading. The company is currently trading at about ~24x forward earnings estimates, so while it may not be a screaming "buy" at current levels, great companies often don't get very inexpensive. We assign P&G a Dividend Cushion ratio of 1.7x, which suggests to us that based on its free cash flow characteristics and balance sheet health, investors should expect years and years of future dividend growth at P&G. We like this Dividend King quite a bit. Shares yield ~2.5%.

Johnson & Johnson (JNJ)

Johnson & Johnson has a lot of moving parts these days following the spin-off of its consumer health division Kenvue (KVUE) in August of last year. Though investors continue to be distracted by talc litigation, J&J's performance in its Innovative Medicine [IM] and MedTech divisions continue to perform well. Adjusted operational sales in IM grew 4.4% in its third quarter of 2023, while worldwide adjusted operational sales in its MedTech division grew 6%. The company also raised the 2023 full-year guidance midpoints for both sales and adjusted EPS.

For the nine months ended October 1, 2023, J&J hauled in $14.93 billion in operating cash flow, while it spent ~$2.95 billion in capital equipment, good for free cash flow generation of ~$11.98 billion. Over the same time period, the firm paid out $8.9 billion in cash dividends, showcasing considerable free cash flow coverage of the dividend. Though it has a net debt position, J&J is one of three companies around the globe that has a pristine AAA credit rating. Its ability to tap the capital markets to support its dividend are second to none.

J&J has raised its dividend in each of the past 60+ years, and we don't see anything that would derail that strong dividend growth track record. On the basis of our discounted cash flow model, we value shares of J&J at $181 per share at the high end of our fair value estimate range, materially higher than where shares are trading at the moment ($160 each). Shares have a very reasonable forward earnings multiple, too, at about 15x next year's expected earnings. Its Dividend Cushion ratio stands at 1.6x, and shares yield ~3%.

Concluding Thoughts

Retirees have a lot of stocks to choose from to generate income, but it's very important to keep the dividend in context. As a shareholder, you already own the cash that will be paid to you as a dividend, making a focus on the fundamentals and financials of a dividend payer even more important. We like to focus on free cash flow and the balance sheet with respect to the forward-looking Dividend Cushion ratio to assess the health of any dividend payer.

Though Procter & Gamble and Johnson & Johnson are well-followed names, we think a look at their Dividend Cushion ratios is a unique aspect of this research that further reinforces a favorable long-term view on their dividend growth prospects. Both P&G and J&J cover their respective payouts comfortably with free cash flow generation, and both have enviable investment-grade credit ratings. We think both Dividend Kings are two dividend growth ideas for a comfortable retirement.

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