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Here's How We Evaluate DXC Technology Company's (NYSE:DXC) Dividend

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Is DXC Technology Company (NYSE:DXC) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 2.6% yield is nothing to get excited about, but investors probably think the long payment history suggests DXC Technology has some staying power. The company also returned around 10.0% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple analysis can reduce the risk of holding DXC Technology for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

NYSE:DXC Historical Dividend Yield, February 10th 2020
NYSE:DXC Historical Dividend Yield, February 10th 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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. While DXC Technology pays a dividend, it reported a loss over the last year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

DXC Technology paid out 9.5% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable.

Is DXC Technology's Balance Sheet Risky?

Given DXC Technology is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With net debt of 1.53 times its EBITDA, DXC Technology has an acceptable level of debt.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. DXC Technology has EBIT of 8.36 times its interest expense, which we think is adequate.

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

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of DXC Technology's dividend payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.60 in 2010, compared to US$0.84 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.4% a year over that time. The dividends haven't grown at precisely 3.4% every year, but this is a useful way to average out the historical rate of growth.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? It's good to see DXC Technology has been growing its earnings per share at 20% a year over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.

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. We're not keen on the fact that DXC Technology paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Next, earnings growth has been good, but unfortunately 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 DXC Technology out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 13 analysts we track are forecasting for DXC Technology for free with public analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 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.