Today we'll take a closer look at ADT Inc. (NYSE:ADT) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
With only a two-year payment history, and a 1.7% yield, investors probably think ADT is not much of a dividend stock. While it may not look like much, if earnings are growing it could become quite interesting. The company also returned around 2.5% of its market capitalisation to shareholders in the form of stock buybacks over the past year. That said, the recent jump in the share price will make ADT's dividend yield look smaller, even though the company prospects could be improving. Some simple research can reduce the risk of buying ADT for its dividend - read on to learn more.
Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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. While ADT pays a dividend, it reported a loss over the last year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.
ADT's cash payout ratio last year was 23%, 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 rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. ADT is carrying net debt of 4.10 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) 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.
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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. Its most recent annual dividend was US$0.14 per share, effectively flat on its first payment two years ago.
It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. ADT's EPS are effectively flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. ADT is paying out less than half of its earnings, which we like. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?
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 the company paying a dividend while being loss-making, although at least the dividend was covered by free cash flow. Second, the company has not been able to generate earnings growth, and its history of dividend payments is shorter than we consider ideal (from a reliability perspective). Ultimately, ADT comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.
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 email@example.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.