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Today we'll take a closer look at Hill-Rom Holdings, Inc. (NYSE:HRC) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A 0.8% yield is nothing to get excited about, but investors probably think the long payment history suggests Hill-Rom Holdings has some staying power. The company also bought back stock equivalent to around 0.6% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. 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. Hill-Rom Holdings paid out 24% of its profit as dividends, over the trailing twelve month period. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Hill-Rom Holdings's cash payout ratio last year was 16%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Hill-Rom Holdings's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Is Hill-Rom Holdings's Balance Sheet Risky?
As Hill-Rom Holdings 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). Hill-Rom Holdings is carrying net debt of 3.18 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 4.36 times its interest expense, Hill-Rom Holdings's interest cover is starting to look a bit thin.
Remember, you can always get a snapshot of Hill-Rom Holdings's latest financial position, by checking our visualisation of its financial health.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of Hill-Rom Holdings's dividend payments. During the past ten-year period, the first annual payment was US$0.41 in 2009, compared to US$0.84 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.4% 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
Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. It's good to see Hill-Rom Holdings has been growing its earnings per share at 14% a year over the past 5 years. Earnings per share are growing at a solid clip, and the payout ratio is low. We think this is an ideal combination in a dividend stock.
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. Firstly, we like that Hill-Rom Holdings has low and conservative payout ratios. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Hill-Rom Holdings has met all of our criteria, including having strong cash flow that covers the dividend. We definitely think it would be worthwhile looking closer.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 9 analysts we track are forecasting for Hill-Rom Holdings 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 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.