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Does Caltex Australia Limited (ASX:CTX) Have A Place In Your Dividend Stock Portfolio?

Simply Wall St

Dividend paying stocks like Caltex Australia Limited (ASX:CTX) 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. 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.

With Caltex Australia yielding 3.4% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock during the year, equivalent to approximately 3.7% of the company's market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

ASX:CTX Historical Dividend Yield, October 30th 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. 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. Caltex Australia paid out 72% of its profit as dividends, over the trailing twelve month period. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Caltex Australia paid out 78% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. 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.

Consider getting our latest analysis on Caltex Australia's financial position 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. For the purpose of this article, we only scrutinise the last decade of Caltex Australia's dividend payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was AU$0.25 in 2009, compared to AU$0.93 last year. This works out to be a compound annual growth rate (CAGR) of approximately 14% a year over that time. The dividends haven't grown at precisely 14% every year, but this is a useful way to average out the historical rate of growth.

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? Over the past five years, it looks as though Caltex Australia's EPS have declined at around 8.1% a year. 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

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we think Caltex Australia is paying out an acceptable percentage of its cashflow and profit. Earnings per share are down, and Caltex Australia's dividend has been cut at least once in the past, which is disappointing. In summary, Caltex Australia has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 10 analysts we track are forecasting for the future.

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.