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Discover Financial Services (NYSE:DFS) Has Got What It Takes To Be An Attractive Dividend Stock

Simply Wall St

Is Discover Financial Services (NYSE:DFS) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

A slim 2.1% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Discover Financial Services could have potential. The company also bought back stock equivalent to around 7.0% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Discover Financial Services for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Discover Financial Services!

NYSE:DFS Historical Dividend Yield, August 8th 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 19% of Discover Financial Services's profits were paid out as dividends in the last 12 months. We'd say its dividends are thoroughly covered by earnings.

We update our data on Discover Financial Services every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

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. Discover Financial Services 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 fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.24 in 2009, compared to US$1.76 last year. This works out to be a compound annual growth rate (CAGR) of approximately 22% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Discover Financial Services has grown its earnings per share at 11% per annum over the past five years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.

Conclusion

To summarise, shareholders should always check that Discover Financial Services's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're glad to see Discover Financial Services has a low payout ratio, as this suggests earnings are being reinvested in the business. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. Discover Financial Services has a credible record on several fronts, but falls slightly short of our standards for a dividend stock.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 20 analysts we track are forecasting for Discover Financial Services 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.