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Here's How We Evaluate Donaldson Company, Inc.'s (NYSE:DCI) Dividend

Simply Wall St

Is Donaldson Company, Inc. (NYSE:DCI) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 1.6% yield is nothing to get excited about, but investors probably think the long payment history suggests Donaldson Company has some staying power. The company also bought back stock equivalent to around 1.7% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Donaldson Company for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

NYSE:DCI Historical Dividend Yield, October 16th 2019

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. 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. Donaldson Company paid out 38% of its profit as dividends, over the trailing twelve month period. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 51% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Donaldson Company has available to meet other needs. 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.

Remember, you can always get a snapshot of Donaldson Company's latest financial position, by checking our visualisation of its financial health.

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. Donaldson Company has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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$0.23 in 2009, compared to US$0.84 last year. Dividends per share have grown at approximately 14% per year over this time.

With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.

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. Donaldson Company has grown its earnings per share at 3.1% per annum over the past five years. Donaldson Company 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.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Firstly, we like that Donaldson Company pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. Overall we think Donaldson Company is an interesting dividend stock, although it could be better.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 7 Donaldson Company 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 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.