Xerox: Dividend Investors Need to Look Beyond 5%+ Yield (NASDAQ:XRX)

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Introduction

We wrote about Xerox Holdings Corporation (NASDAQ: XRX) in March when we declared the stock to be a great income play. In fact, stocks have been basically flat since we wrote this 10 week article. there is what actually reinforces our initial view for the following reason. True income-oriented investors prefer lower prices in their respective dividend-paying stocks because compounding within the portfolio can take place at a much faster rate compared to standard terms. Suffice it to say that when one can obtain more income-generating assets (stocks) for the same amount each month, quarter, etc., it means more income in the long term compared to the position indicated.

However, given the high inflation backdrop investors are currently facing, earning a substantial above-average dividend yield may not actually cut the mustard for Xerox investors. Remember, these are real returns going forward, as nominal returns of 5.4% (Xerox’s forward dividend yield) simply won’t do if inflation stays well above this number for the foreseeable future. The problem with basing a methodology on a single metric, for example (dividend yield), is that the “total return” potential of the game is ignored to a large extent, which brings me to the following, which is poignant for all dividend-focused investors. in the current climate.

As long as inflation remains at current high single digit levels, all dividend-paying companies will simply have to earn more than their prevailing yields to ensure that investors don’t lose significant purchasing power.

So from that vantage point, let’s look at Xerox from a “total return” perspective to see if we can get a glimpse of where this game is heading in the future.

Xerox Tech Chart

Xerox Weekly Chart (StockCharts.com)

XRX Evaluation

Although Xerox shares do not currently trade with a positive earnings multiple, the company’s cash flow multiple of 4.96, accounting multiple of 0.69 and sales multiple of 0 .46 all look very attractive compared to historical numbers. In fact, Xerox’s current free cash flow yield of approximately 18% clearly demonstrates that the company has the financial clout to meet its debts and liabilities. Additionally, the company’s accounting and sales multiples are expected to decline in the current fiscal year, respectively, which essentially means that sales, as well as assets, are both expected to increase. Suffice it to say, asset growth and sales (which are currently cheap by any measure) is exactly the setup we’re looking for in stocks with attractive valuations. An encouraging start to say the least.

Profitability

The reason for the negative net profit imprint in the last four quarters is due to the goodwill impairment charge of $750 million in the fourth quarter of last year. Therefore, despite Xerox’s obvious prowess in generating consistent free cash flow, the heavy charge to the income statement clearly shows how affected the company’s printing business has been lately. This “need” for a more robust return to the office clearly shows the fragilities of the printing segment and how margins have been affected accordingly higher up in the income statement. Gross margins of 33.19% on a 12-month average are well below the 5-year average of 38.83%. Additionally, operating margins of 4.4% are now less than half of the company’s 5-year average of 9%. These unfavorable margin trends mean that the net earnings estimate for fiscal 2022 is now 27% and more lower than it was just 30 days ago. A worrying trend.

Returns to shareholders

Despite Xerox’s current profitability headwinds, management continues to buy back stock at a breakneck pace. As of this writing, the total number of shares outstanding is 154.86 million, which means the free float has already dropped by nearly 30 million shares since the start of this fiscal year. The forward dividend yield of 5.4% needs no introduction, although the quarterly payout has been locked in at $0.25 per share for many years now. Due to strong cash flow generation, there are no affordability concerns as Xerox’s cash dividend payout ratio currently stands at 37.71% on a trailing twelve month average. However, the company’s cash balance has fallen by about $700 million over the past 12 months to facilitate these returns. Suffice it to say, this is about stronger profitability going forward, as the above trends are not sustainable unless earnings are there to meet those commitments.

Conclusion

A good way to gauge the total return potential of a given stock is to monitor its valuation, profitability trends as well as shareholder compensation. We have no problem with Xerox’s valuation or how management rewards its shareholders. The problem is the company’s profitability, which simply needs to improve for the market to value this stock higher. We look forward to continued coverage.