U.S. Markets closed

Is AGL Energy Limited's (ASX:AGL) 5.8% Dividend Worth Your Time?

Simply Wall St

Is AGL Energy Limited (ASX:AGL) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

A high yield and a long history of paying dividends is an appealing combination for AGL Energy. We'd guess that plenty of investors have purchased it for the income. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on AGL Energy!

ASX:AGL Historical Dividend Yield, December 2nd 2019

Payout ratios

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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Looking at the data, we can see that 86% of AGL Energy's profits were paid out as dividends in the last 12 months. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. AGL Energy paid out 113% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. AGL Energy paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to AGL Energy's ability to maintain its dividend.

Remember, you can always get a snapshot of AGL Energy'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. For the purpose of this article, we only scrutinise the last decade of AGL Energy's dividend payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was AU$0.53 in 2009, compared to AU$1.19 last year. Dividends per share have grown at approximately 8.4% per year over this time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

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. Earnings have grown at around 7.0% a year for the past five years, which is better than seeing them shrink! Past earnings growth has been decent, but unless this is one of those rare businesses that can grow without additional capital investment or marketing spend, we'd generally expect the higher payout ratio to limit its future growth prospects.

Conclusion

To summarise, shareholders should always check that AGL Energy's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think AGL Energy has an acceptable payout ratio, although its dividend was not well covered by cashflow. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. In sum, we find it hard to get excited about AGL Energy from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 11 analysts we track are forecasting for AGL Energy 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%.

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.

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. Thank you for reading.