This strategy helps portfolio managers identify Dividend Champions and companies where Dividends are At Risk. 

Portfolio managers face a constant challenge regarding the reliability and consistency of long-term dividend returns. Are long-term dividend returns sticky and assured, or may a negative dividend announcement be just around the corner? When combined with a poor profitability outlook, does a stretched balance sheet pose risks to future dividends? While traditional dividend analysis based on indicators such as yield and cover is still valuable, it is also essential to focus on the core underlying phenomenon that generates cash flow for dividends — the outlook for shareholder value creation. Our metric of I-EVA (incremental economic value added) captures the outlook for incremental value creation. As a leading indicator of future profitability, companies with strong I-EVA trends are likelier to have more robust profitability and balance sheets. The I-EVA metric can be integral to an income-focused investment strategy as it indicates whether management is establishing a solid groundwork for a sustainable dividend policy. It is also essential to evaluate management’s capital allocation strategy for its role in a company’s ability to sustain dividends.

Philosophy

What is dividend quality? An ideal high-quality dividend stock has high yields and a strong forecasted I-EVA. High-quality dividend stocks need not be limited to bond proxies such as utilities or high-yield stocks. To be considered high-quality, dividends should grow sustainably, matching or exceeding benchmarks such as the peer group payout-average or the inflation rate. Dividends are, therefore, “at risk,” not just when there’s a potential for a cut in payout but also if they don’t increase at the anticipated rate, whether peer average or inflation rate.

Importance of I-EVA: Companies with strong I-EVA trends are more likely to have sustainable or even accelerated capital returns to shareholders, as they will likely have more robust profitability and balance sheets. For example, an accelerating forecast I-EVA could signal that dividends are not just secure and that there could be an upside to payouts.

Contrarian: When faced with a weak dividend cover outlook, investors can be discouraged from considering many dividend plays. While this may appear logical, we would focus on that core underlying phenomenon that ultimately creates the cash flow for dividends — the I-EVA. Strong forecast I-EVA trends, particularly in momentum, could signal that profitability trends are at a turning point for investing purposes.

Limitations of traditional analysis: Dividend cover strength is a popular measure to check whether future dividends are sufficiently covered against future cash flow generation. However, it possesses limitations when comparing companies across industries. Incorporating I-EVA into dividend analysis gives a better indicator of relative attractiveness across industries than one based on cash flow forecasts.

Financial leverage and dividends: In times of low and favorable interest rates, companies might choose to increase financial leverage through borrowing to fund dividends. We identify instances where financial leverage has been utilized for dividend funding.

Capital allocation and dividends: Companies can use various capital allocation strategies to create shareholder value and generate a consistent dividend stream. A heavy capital expansion and high payout ratios accompanied by weakening I-EVA forecasts could indicate that dividends could be at risk. Companies pursuing a less aggressive approach to invested capital deployment and reinvesting in the business are less risky from the point of view of posing a threat to dividend payments if forecast I-EVA trends are healthy.

Dividend at Risk: Stocks where the dividend outlook appears at risk.

This framework hinges on these key pillars:

• Weak Forecast Incremental Value Creation (I-EVA): We identify those facing weak I-EVA forecast trends, indicating a likelihood of deterioration in shareholder value creation — asking questions about the sustainability of dividend payments
• Weak Dividend Cover: Weak dividend cover strength indicates that future dividends carry insufficient cover against future cash flow generation.
• Aggressive Capital Allocation: Companies pursuing an aggressive strategy pose a threat to dividends, particularly if forecast I-EVA trends are not healthy.
• High Financial Leverage: Dividend yield (adjusted for debt) shows how much financial leverage has been adopted to fund dividends. An adjusted value lower than a plain dividend yield indicates that financial leverage has been adopted to fund dividends.
• Payout ratios: Investors should be cautious of companies with high dividend yield and payout ratios if their I-EVA trends continue to deteriorate, as it may lead to shareholder value erosion and weaken the balance sheet.

Dividend Champions: The most solid dividend stocks to own in the sector.

This framework hinges on these key pillars:

• Strong Forecast Incremental Value Creation (I-EVA): We identify those likely to display I-EVA forecast trends, indicating a likelihood of improvement in shareholder value creation, making sustainability of dividend payments a likely proposition.
• Strong Dividend Cover: Strong dividend cover strength indicates that future dividends are sufficiently covered against future cash flow generation.
• High Dividend Yield: Stocks enjoying higher dividend yields are short-listed.
• Modest net debt: identify those set to enjoy strong acceleration in forecast I-EVA — necessary for sustained dividend payments — and those with relatively low debt ratios.