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Is Domino's Pizza Enterprises Limited (ASX:DMP) A Smart Choice For Dividend Investors?

Simply Wall St

Today we'll take a closer look at Domino's Pizza Enterprises Limited (ASX:DMP) 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. 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 2.1% yield is nothing to get excited about, but investors probably think the long payment history suggests Domino's Pizza Enterprises 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.

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ASX:DMP Historical Dividend Yield, January 6th 2020

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. Domino's Pizza Enterprises paid out 85% of its profit as dividends, over the trailing twelve month period. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Domino's Pizza Enterprises paid out 180% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. Domino's Pizza Enterprises paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Domino's Pizza Enterprises's ability to maintain its dividend.

Is Domino's Pizza Enterprises's Balance Sheet Risky?

As Domino's Pizza Enterprises 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). With net debt of 2.17 times its EBITDA, Domino's Pizza Enterprises has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 14.44 times its interest expense, Domino's Pizza Enterprises's interest cover is quite strong - more than enough to cover the interest expense.

Consider getting our latest analysis on Domino's Pizza Enterprises's financial position here.

Dividend Volatility

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 Domino's Pizza Enterprises's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was AU$0.11 in 2010, compared to AU$1.16 last year. This works out to be a compound annual growth rate (CAGR) of approximately 26% a year over that time.

It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but Domino's Pizza Enterprises has done it, which we really like.

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. It's good to see Domino's Pizza Enterprises has been growing its earnings per share at 22% a year over the past five years. Domino's Pizza Enterprises earnings have been growing very quickly recently, but given that it is paying out more than half of its earnings, we wonder if it will have enough capital to fund further growth in the future.

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, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Domino's Pizza Enterprises out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 11 Domino's Pizza Enterprises analysts we track are forecasting continued growth with our free report on 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%.

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.

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. Thank you for reading.