Could American Electric Power Company, Inc. (NYSE:AEP) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.
A 3.0% yield is nothing to get excited about, but investors probably think the long payment history suggests American Electric Power Company has some staying power. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
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. Looking at the data, we can see that 66% of American Electric Power Company'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.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while American Electric Power Company pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is American Electric Power Company's Balance Sheet Risky?
As American Electric Power Company 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 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. American Electric Power Company has net debt of 5.51 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 2.74 times its interest expense, American Electric Power Company's interest cover is starting to look a bit thin. Low interest cover and high debt can create problems right when the investor least needs them, and we're reluctant to rely on the dividend of companies with these traits.
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. For the purpose of this article, we only scrutinise the last decade of American Electric Power Company'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 US$1.64 in 2009, compared to US$2.68 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.0% a year over that time.
Businesses that can grow their dividends at a decent rate and maintain a stable payout can generate substantial wealth for shareholders over the long term.
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. American Electric Power Company has grown its earnings per share at 5.8% per annum over the past five years. Earnings per share are growing at an acceptable rate, although the company is paying out more than half of its profits, which we think could constrain its ability to reinvest in its business.
To summarise, shareholders should always check that American Electric Power Company'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 American Electric Power Company has an acceptable payout ratio, although its dividend was not well covered by cashflow. It hasn't demonstrated a strong ability to grow earnings per share, but we like that the dividend payments have been fairly consistent. In sum, we find it hard to get excited about American Electric Power Company 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 10 analysts we track are forecasting for American Electric Power Company for free with public analyst estimates for the company.
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 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. Thank you for reading.