U.S. Markets open in 8 hrs 20 mins

Should You Buy ResMed Inc. (NYSE:RMD) For Its Dividend?

Simply Wall St

Today we'll take a closer look at ResMed Inc. (NYSE:RMD) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

Investors might not know much about ResMed's dividend prospects, even though it has been paying dividends for the last seven years and offers a 1.1% yield. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. Some simple analysis can reduce the risk of holding ResMed for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

NYSE:RMD Historical Dividend Yield, October 29th 2019

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. 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 52% of ResMed's profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, ResMed paid out 44% as dividends, suggesting the dividend is affordable. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Remember, you can always get a snapshot of ResMed'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. Looking at the data, we can see that ResMed has been paying a dividend for the past seven years. Its dividend has not fluctuated much that time, which we like, but we're conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past seven-year period, the first annual payment was US$0.68 in 2012, compared to US$1.56 last year. This works out to be a compound annual growth rate (CAGR) of approximately 13% a year over that time.

ResMed has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. ResMed has grown its earnings per share at 3.7% per annum over the past five years. Growth of 3.7% is relatively anaemic growth, which we wonder about. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.

Conclusion

To summarise, shareholders should always check that ResMed'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 ResMed has an acceptable payout ratio and its dividend is well covered by cashflow. Unfortunately, earnings growth has also been mediocre, and we think it has not been paying dividends long enough to demonstrate resilience across economic cycles. Ultimately, ResMed 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 13 analysts we track are forecasting for ResMed for free with public analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.