Dividend paying stocks like Cleveland-Cliffs Inc. (NYSE:CLF) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. 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.
In this case, Cleveland-Cliffs likely looks attractive to investors, given its 3.4% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. The company also returned around 13% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple research can reduce the risk of buying Cleveland-Cliffs for its dividend - read on to learn more.
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. In the last year, Cleveland-Cliffs paid out 22% of its profit as dividends. We'd say its dividends are thoroughly covered by earnings.
Is Cleveland-Cliffs's Balance Sheet Risky?
As Cleveland-Cliffs has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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. With net debt of 3.38 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 4.30 times its interest expense is starting to become a concern for Cleveland-Cliffs, and be aware that lenders may place additional restrictions on the company as well.
Consider getting our latest analysis on Cleveland-Cliffs's financial position here.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Cleveland-Cliffs has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.16 in 2010, compared to US$0.24 last year. Dividends per share have grown at approximately 4.1% per year over this time. Cleveland-Cliffs's dividend payments have fluctuated, so it hasn't grown 4.1% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.
We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Cleveland-Cliffs's EPS have fallen by approximately 32% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Cleveland-Cliffs's earnings per share, which support the dividend, have been anything but stable.
To summarise, shareholders should always check that Cleveland-Cliffs's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Cleveland-Cliffs has a low and conservative payout ratio. Earnings per share are down, and Cleveland-Cliffs's dividend has been cut at least once in the past, which is disappointing. Cleveland-Cliffs might not be a bad business, but it doesn't show all of the characteristics we look for in a dividend stock.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 4 analysts we track are forecasting for the future.
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 firstname.lastname@example.org. 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.
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