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Are Dividend Investors Getting More Than They Bargained For With Tullow Oil plc's (LON:TLW) Dividend?

Simply Wall St

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Is Tullow Oil plc (LON:TLW) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A slim 1.8% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Tullow Oil could have potential. 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 Tullow Oil!

LSE:TLW Historical Dividend Yield, July 3rd 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Tullow Oil paid out 79% of its profit as dividends, over the trailing twelve month period. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

Is Tullow Oil's Balance Sheet Risky?

As Tullow Oil has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). Tullow Oil has net debt of 3.79 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.00 times its interest expense is starting to become a concern for Tullow Oil, and be aware that lenders may place additional restrictions on the company as well.

Consider getting our latest analysis on Tullow Oil's financial position here.

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 Tullow Oil's dividend payments. During the past ten-year period, the first annual payment was US$0.082 in 2009, compared to US$0.048 last year. The dividend has shrunk at around 5.2% a year during that period.

A shrinking dividend over a ten-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. It's not great to see that Tullow Oil's have fallen at approximately 20% over the past five years. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

Conclusion

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. Tullow Oil's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Earnings per share are down, and Tullow Oil's dividend has been cut at least once in the past, which is disappointing. Ultimately, Tullow Oil 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.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 16 analysts are forecasting a turnaround in our free collection of analyst estimates here.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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 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.