What to Do When a Dividend Aristocrat Trips

In financial parlance that befits a royal family, Johnson & Johnson (ticker: JNJ) is known in financial parlance as a "dividend aristocrat." For 56 years now -- ever since John F. Kennedy was in the White House -- the health care and pharmaceutical giant has increased payouts every consecutive year.

The latest quarterly disbursement stands at 95 cents per share. That's already up a nickel from the previous payout and double what it was in 2009. Nothing has been able to stop the dividend growth, not even the Great Recession that shipwrecked many a juggernaut company, such as Citigroup ( C).

Yet in 2019, the New Jersey-based health care colossus has faced bad news that not even a semi full of Band-Aids can patch up. In March, an Oakland, California, jury awarded Teresa Leavitt $29 million over allegations that the company's talcum-based baby powder contained asbestos that caused her to develop mesothelioma. Aside from opening the door to similar judgments, the verdict also dumps a ton of bad publicity atop one of JNJ's flagship products.

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And just recently, Johnson & Johnson went on trial in Oklahoma after the state accused it of overproducing painkillers and contributing to the opioid epidemic. It marks the first civil trial that seeks to hold a pharmaceutical company accountable for the opioid crisis.

While there's no telling how all this could affect future dividends, there remains the ever-current barometer of share price. And that tanked by 12% in one day in December 2018 after news stories circulated that company officials knew for decades about the asbestos-talc powder issues. Still, the stock is up 10% year over year, trading at about $139 per share, and remains a dividend aristocrat list and exchange-traded fund (ETF) favorite.

And so despite the volatility, the company's dynasty as dividend royalty appears safe for the time being.

"Regarding JNJ, they will likely continue to increase the dividend unless there is a catastrophic loss in courts after appeals that requires them to pay a huge settlement that would drastically alter their balance sheet," says Timothy Parker, partner at Regency Wealth Management in Ramsey, New Jersey.

In fact you could say that cash is dividend king.

"One of the prime benefits of investing in a dividend king is that in order to pay dividends, companies must produce cold, hard cash," says Robert Johnson, a finance professor at Creighton University's Heider College of Business. "That is, they have to produce sufficient cash flow to maintain the dividend and, indeed, keep increasing the dividend over time. Investors should pay attention to free cash flow per share. JNJ's free cash flow per share continues to rise."

Indeed, balance sheets offer major insight for the investor who fears volatility and the overthrow of a dividend king. That's the case with General Electric Co. ( GE), a company that has seen its once omnipotent dividend payout go into virtual non-existence.

GE took a terrible tumble from its dividend aristocrat throne in November 2017, when it chain-sawed its dividend in half: from 24 to 12 cents per share quarterly. For the company co-founded by Thomas Edison, it was only the second cut since the Great Depression.

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But it wasn't the last. In October, CEO Larry Culp eviscerated what was left, lowered the 119-year-old payout to just a penny. The same day that news hit, GE further shocked shareholders when it failed to provide any forward guidance and announced an investigation into its accounting practices by the Securities and Exchange Commission and U.S. Justice Department.

In the meantime, putting the once-robust payout on life support freed up an estimated $3.9 billion in cash annually for the dividend stock.

"General Electric's collapse should have served as a reminder that buying a company based solely on past reputation and dividend yield is a dangerous endeavor," says Vitaliy Katsenelson, chief investment officer at Investment Management Associates in Greenwood, Colorado.

"GE is also a great example that dividends are not paid out of earnings -- especially massaged-to-death non-GAAP earnings -- but from free cash flows," he adds.

Earnings listed as non-GAAP (standing for generally accepted accounting principles) employ alternative measurement methods and can mislead as they often exclude items that have a negative financial impact.

"GE's non-GAAP earnings were double its dividend payment," Katsenelson says.

None of this, of course, should take away from the dividend aristocrats that continue to report more than a half century of consecutive raises. These stocks include Dover Corp. ( DOV), 3M Co. ( MMM), Target Corp. ( TGT) -- and the all-time champ, American States Water Co. ( AWR). At 64 years, it's a dividend king of nearly senior citizen proportions.

Which raises a point of nomenclature: Maybe the name "dividend king" exposes that when it comes to blockbuster dividend growth, the emperor has no clothes.

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"They're old-time dividend growers that have been raising dividends for decades, but at very low growth rates," says Kian Salehizadeh, senior analyst at Blockforce Capital in San Diego.

Salehizadeh has a unique description for companies that would form a dividend aristocrats index.

"We refer to many of those names as 'grandma stocks,'" he says.