Ford’s dividend quality, J&J’s split-off, cost basis discipline
Send your questions directly to Jim Cramer and his team of analysts at investingclubmailbag@cnbc.com. As a reminder, we are unable to provide personal investment advice. We will only consider more general questions about the investment process or stocks in a portfolio or related industries. Question 1: How do you feel about the stability of Ford’s dividend? Thanks Dennis, the quickest way to determine the sustainability of a company’s dividend is to consider it in relation to earnings and/or cash flow. The dividend payout divided by the earnings figure is known as the “payout ratio” — anything below 100% is generally considered sustainable (as long as it’s positive). Negative numbers mean negative returns, which is obviously bad. A payout ratio above 100% is also of concern, as it means the company is paying out more than it earns, thus draining the cash on its balance sheet, which is clearly an unsustainable dynamic. The method is not the end result of everything. We say this for two reasons. First, earnings fluctuate and so do payout ratios (assuming no change in dividend payments). Second, in addition to earnings fluctuations, we must always consider the financial health of the company. If we have reason to believe that future earnings conditions will change (either improving or declining), then we need to factor that into our view of the payout ratio. Therefore, it may be helpful to consider past performance and future expectations. Looking at the club name Ford (F), we see the following data from FactSet. Based on adjusted earnings per share (shown in the table above on the row below the dividend per share), Ford generates enough income from normal operations (which is what adjusted earnings try to emphasize by excluding one-time charges) to pay dividends to shareholders like us. This is because all the numbers in the “Adjusted EPS Payout Ratio” row (actual 2021 and 2022 results and forecast 2023 and 2024 results) are positive, and each is below 100%. As a caveat, we must remember that adjusted earnings do not equal cash flow, and dividends cannot be paid in IOUs. It is for this reason that we always say compare cash flow to earnings numbers to get an idea of earnings quality. The more actual cash backing those earnings, the higher the quality. Fortunately, what we’ve seen in Ford’s case is that in addition to generating enough earnings, they’ve also attracted enough cold hard cash to cover expenses, as shown in the bottom line of the table in the “Cash Flow Payout Ratio per Share” table, which is positive and below 100%. That said, if we see cash and/or cash flow not being able to cover expenses for a certain period, it is not necessarily grounds for bail. However, this is something that needs to be investigated. Remember, the question is about long-term sustainability, not one or two quarters over the years. So using a bit of cash occasionally in a difficult operating environment is acceptable in most cases, as long as you have confidence that things will normalize and the payout ratio will drop back below 100% before problems arise. Of course, anything could happen, such as a global pandemic forcing a dividend cut — but under normal operating conditions, the above numbers give us confidence in Ford’s ability to continue paying its quarterly dividend. When investing in dividend-paying stocks, it’s a good idea to check these ratios as part of your homework, and to review any upcoming cash payments, such as debt maturities. These events are sure to cut into earnings and scramble for cash flow. However, analysts are often able to incorporate this information into their forecasts. Question 2: Hello, what is the progress of the Johnson & Johnson spin-off (KVUE)? Will the current owners of JNJ get any shares in KVUE? — WT We actually just got an update on this in Johnson & Johnson’s (JNJ) Q2 earnings release. The company is seeking a so-called “spin-off” of its remaining majority stake, meaning management will make a tender offer and Johnson & Johnson shareholders will have the option to swap those stakes for Kenvue (KVUE) shares. We own stock in Johnson & Johnson. As we noted in our analysis of J&J’s latest release, we like this decision because it enables the company to divest its Kenvue stake (currently 89.6% owned) while potentially (depending on how many investors choose to accept the offer) “a tax-free one-time acquisition of a substantial amount of J&J common stock.” It’s almost like a buyback, but instead of using cash, allowing the team to maintain the company’s future financial flexibility. Question 3: I know it’s not that simple, and I know that as much discipline as possible should be maintained around the cost base to generate future benefits. However, I have also had many times when I have been lucky enough to buy stocks at or near their lows. However, on the first few incremental purchases, I did not purchase enough to cover the original quantity I wished to purchase. The stock’s questionable gains have left me behind. …I hope you can expand a bit on situations like this. Thank you Jeff and your team for everything you do. You did very well. —Larry That’s not an easy question to answer. Our discipline, as you said, is not to violate our cost base, and we try to stick to that as much as possible. That said, we sometimes violate this discipline, but we don’t take it lightly. We cannot provide specific rules as to when this is acceptable. After all, investing is as much a science as it is an art. However, we can offer some food for thought. We tend to think of these situations as “quality problems” – when a person makes money but not as much as they think they should because they never get the full position. Sometimes the best course of action is to win small or go with the flow until a clear buying opportunity arises (such as a market-wide correction or a complete dislocation between a stock and its fundamentals). Remember, price is what you pay, value is what you get. If the appreciation is the result of earnings growth, it’s entirely possible for the stock to rise in price but not become more expensive on a valuation basis. In this case, one may find that violating their basis is acceptable because they will be violating their cost basis in terms of price, but won’t necessarily get a worse deal than before if the multiple is unchanged. They might even get a better deal if the multiple falls. This is one way of thinking about whether it is acceptable to violate the foundations. Think of Nvidia, on the one hand, and one might think it’s crazy to buy the company’s stock at $380 a share after earnings soared in May. On the other hand, the stock’s gains have barely met earnings estimates — and as a result, the price-to-earnings (P/E) multiple has actually shrunk (became cheaper in value). Now, our share price is over $450. NVDA YTD mountain Nvidia YTD performance Another way to look at the above is to think of your small position as if you had no position at all. Remember, we care about where a stock is going, not where it came from. Thinking of the title as if you don’t have an existing position might help you think more objectively about the risk/reward at your current level. Would you still buy the recent move if you completely missed it? In the end, discipline is adherence to your cost basis. However, if you’re considering violating it, thinking about the name from a valuation (rather than price) perspective, as if you weren’t already exposed, might help determine whether this is indeed the right course of action. (See here for a full list of INJim Cramer Charitable Trust stocks.) As a CNBC Investment Club Jim Cramer subscriber, you will receive trade alerts before Jim places them. Jim waits 45 minutes after a trade alert is sent before buying or selling stock in his charitable trust portfolio. If Jim talks about a stock on CNBC TV, he waits 72 hours after sending out a trade alert before executing the trade. The investment club information above is subject to our terms and conditions and privacy policy and our disclaimer. No fiduciary duty or obligation exists or arises from any information you receive in connection with Investment Club. No specific results or profits guaranteed.
Send your questions directly to Jim Cramer and his team of analysts at investingclubmailbag@cnbc.com. As a reminder, we are unable to provide personal investment advice. We will only consider more general questions about the investment process or stocks in a portfolio or related industries.
Question 1: How do you feel about the stability of Ford’s dividend?thank you, denise
Svlook
