Monday, March 27, 2006

How to pick stocks with potential for increased dividends

A critical financial ratio when evaluating a company’s strength is its ratio of cash flow from operations relative to the sum of capital expenditures and dividends. [ CFO/( CapEx + Dividends) ]. The ratio of cash generated to cash required (CGCR) measures a companies ability to sustain and increase its dividends while reinvesting in its operations. Companies with high ratios of CGCR have a margin of safety because they have more cash to spend on growth expenditures and dividend payouts.

This ratio is fairly obscure, and yet very important because it is an excellent indicator of financially strong companies with the potential to raise dividends. Increasing dividends bring good publicity and are catalyst for higher share prices. In general, companies with CGCR ratios above 2.0 have the potential to raise dividends safely. The merits of cheap stocks with the potential for dividend increases are obvious.