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Here's What You Should Know About AbbVie Inc.'s (NYSE:ABBV) 6.3% Dividend Yield

Simply Wall St

Today we'll take a closer look at AbbVie Inc. (NYSE:ABBV) 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.

With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if AbbVie is a new dividend aristocrat in the making. It sure looks interesting on these metrics - but there's always more to the story . The company also bought back stock equivalent to around 3.7% of market capitalisation this year. Some simple analysis can reduce the risk of holding AbbVie for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

NYSE:ABBV Historical Dividend Yield, August 22nd 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. AbbVie paid out 152% of its profit as dividends, over the trailing twelve month period. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. AbbVie paid out a conservative 48% of its free cash flow as dividends last year. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and AbbVie fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is AbbVie's Balance Sheet Risky?

As AbbVie's dividend was not well covered by earnings, 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 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 2.14 times its EBITDA, AbbVie has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 10.39 times its interest expense appears reasonable for AbbVie, although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of AbbVie'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. Looking at the data, we can see that AbbVie has been paying a dividend for the past seven years. The dividend has been quite stable over the past seven years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past seven-year period, the first annual payment was US$1.60 in 2012, compared to US$4.28 last year. This works out to be a compound annual growth rate (CAGR) of approximately 15% a year over that time.

AbbVie has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

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. AbbVie's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. Still, the company has struggled to grow its EPS, and currently pays out 152% of its earnings. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.

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 AbbVie paid out such a high percentage of its income, although its cashflow is in better shape. Unfortunately, there hasn't been any earnings growth, and the company's dividend history has been too short for us to evaluate the consistency of the dividend. In sum, we find it hard to get excited about AbbVie from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 11 AbbVie 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%.

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.