Continuing last week’s article, learn more about the importance of cash from operations. Here I provide examples of when this metric helps to clarify the real situation and explain how we use it in our stock analysis at DSR.
BCE.TO / BCE
Below you see the cash from operations, total dividends paid and free cash flow over the past 5 years for BCE (BCE.TO / BCE). As of September 2023, BCE’s dividend payout ratio is at 126.95%, but its cash payout ratio is at 171.05%. Do you think the dividend is at risk?
Let’s see how the company has been generating cash during this period.
We see that BCE disbursed $3.569B in dividends over the past 12 months while generating only $2.157B in free cash flow. Remember, however, that capital expenditures are being deducted from cash flow to calculate the free cash flow. Since BCE invests massively in its network infrastructure, including 5G development, its free cash flow isn’t enough to pay the dividends.
But looking at the cash from operations, we see that BCE generates more than double the amount required to pay their dividends. This reveals that the company is borrowing money to finance its CAPEX in wireless network infrastructure and has plenty of cash flow to pay its dividends.
This explains how management has kept the dividend growth streak alive while showing ridiculously high payout ratios.
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Exxon Mobile (XOM)
A quick look at Exxon Mobil (XOM) shows how 2020 with the start of the pandemic rapidly “killed” the company’s cash flow generation.
While the XOM cash flow reduced rapidly during 2020, it didn’t mean the end for their shareholders. All depended on how long the price of a barrel of crude oil’s stayed depressed. Fortunately for investors, demand rapidly returned and XOM is now generating historical record cash flows.
With such hectic cash flow generation, you can see why I find it so hard to “trust” oil companies to constantly increase their dividends. While operating cash flow is a particularly important metric to follow, it can be extremely volatile at times. This is one of the metric’s most important downsides.
If matters that much, why isn’t it highlighted in quarterly earnings?
That’s a very good question. Another question is, if cash from operations is so important and crucial for a business, why don’t we use it instead of earnings in the DSR dividend triangle?
In the next graph, I’ve pulled out some random companies in different sectors to show you how variable cash from operations can be.
Note that all stocks in the graph performed better than the market. Apple is the top performer in terms of total return over the past 5 years, yet it still doesn’t show a steady cash from operations trend. When you look at Lockheed Martin, Royal Bank and Canadian National Railway’s cash flow graphs, cash from operations bouncing up and down all the time is quite easy to see. So, cash from operations can be volatile.
Think how your bank account fluctuates from month to month. Most of the time it is clearly stable. If you’re making more money than you spend, you will see your bank account (or savings) grow gradually. Then life happens, and you need to replace both your refrigerator and your dishwasher at the same time (true story, happened to me this month!) your cash flow is all over the place. This teaches us, once again, that a single metric can’t explain everything.
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Using cash from operations in stock analysis
At DSR, we use earnings per share (EPS) for our dividend triangle mostly because it’s an easy metric to obtain. The second reason is that cash from operations can be volatile. Over a longer period, we see trends defining where a company is going. Obviously, a company cannot bleed money for an extended period of time before other side effects are plainly visible.
Therefore, the trend of cash from operations is in our second set of metrics to analyze. When we’re done with the dividend triangle, we look at the dividend and cash dividend payout ratios along with long-term debt and cash from operations (also called operating cash flow) trends.
The combination of several metrics is the key to a well-defined investing analyses process. When you find a company with a strong dividend triangle, you usually find a company with decent payout ratios, debt under control, and growing cash flows.
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