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Should ADT Inc. (NYSE:ADT) Be Part Of Your Dividend Portfolio?

Simply Wall St

Could ADT Inc. (NYSE:ADT) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

ADT has only been paying a dividend for a year or so, so investors might be curious about its 2.3% yield. The company also bought back stock equivalent to around 0.6% of market capitalisation this year. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on ADT!

NYSE:ADT Historical Dividend Yield, May 17th 2019

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Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Although it reported a loss over the past 12 months, ADT currently pays a dividend. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

As a loss-making company, we can also measure ADT's dividend payments against its levered free cash flow, to see if enough cash was generated to cover the dividend. ADT's cash payout ratio last year was 21%, which is quite low and suggests that the dividend was thoroughly covered by cash flow.


Is ADT's Balance Sheet Risky?

Given ADT is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). ADT has net debt of more than 3x its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. ADT has interest cover of less than 1 - which suggests its earnings are not high enough to cover even the interest payments on its debt. This is potentially quite serious, and we would likely avoid the stock if it were not resolved quickly.

Remember, you can always get a snapshot of ADT's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. This company has been paying a dividend for less than 2 years, which we think is too soon to consider it a reliable dividend stock. Its most recent annual dividend was US$0.14 per share, effectively flat on its first payment one years ago.

We like that the dividend hasn't been shrinking. However we're conscious that the company hasn't got an overly long track record of dividend payments yet, which makes us wary of relying on its dividend income.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. It's good to see ADT has been growing its earnings per share at 15% a year over the past 5 years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. We're a bit uncomfortable with its high payout ratio, although we note cashflow was stronger than income. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than ADT out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 7 analysts we track are forecasting for ADT for free with public analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.