Today we'll take a closer look at Fastenal Company (NASDAQ:FAST) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
A 2.4% yield is nothing to get excited about, but investors probably think the long payment history suggests Fastenal has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Fastenal paid out 62% of its profit as dividends. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Fastenal paid out 96% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Fastenal 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 Fastenal's ability to maintain its dividend.
Remember, you can always get a snapshot of Fastenal's latest financial position, by checking our visualisation of its financial health.
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 Fastenal's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.17 in 2009, compared to US$0.88 last year. This works out to be a compound annual growth rate (CAGR) of approximately 18% a year over that time. Fastenal's dividend payments have fluctuated, so it hasn't grown 18% every year, but the CAGR is a useful rule of thumb for approximating the historical 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
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. It's good to see Fastenal has been growing its earnings per share at 13% a year over the past five years. Fastenal's earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.
To summarise, shareholders should always check that Fastenal'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 Fastenal has an acceptable payout ratio, although its dividend was not well covered by cashflow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Fastenal out there.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 15 analysts we track are forecasting for Fastenal 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%.
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If you spot an error that warrants correction, please contact the editor at email@example.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.