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Dividend paying stocks like Kennametal Inc. (NYSE:KMT) 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.
A slim 2.4% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Kennametal could have potential. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. Kennametal paid out 26% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. With a cash payout ratio of 100%, Kennametal's dividend payments are poorly covered by cash flow. Kennametal paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Kennametal to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.
We update our data on Kennametal every 24 hours, so you can always get our latest analysis of its financial health, here.
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 Kennametal'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$0.48 in 2009, compared to US$0.80 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.2% 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
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Kennametal has grown its earnings per share at 3.4% per annum over the past five years. Kennametal is paying out less than half of its earnings, which we like. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.
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 like Kennametal's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Kennametal out there.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 11 Kennametal analysts we track are forecasting continued growth with our free report on 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.