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Investors In The Goodyear Tire & Rubber Company (NASDAQ:GT) Should Consider This, First

Simply Wall St

Dividend paying stocks like The Goodyear Tire & Rubber Company (NASDAQ:GT) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a six-year payment history and a 4.2% yield, many investors probably find Goodyear Tire & Rubber intriguing. We'd agree the yield does look enticing. The company also bought back stock during the year, equivalent to approximately 0.5% of the company's market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

NasdaqGS:GT Historical Dividend Yield, December 23rd 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. Looking at the data, we can see that 78% of Goodyear Tire & Rubber's profits were paid out as dividends in the last 12 months. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Goodyear Tire & Rubber paid out 339% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. 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. Goodyear Tire & Rubber 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 Goodyear Tire & Rubber's ability to maintain its dividend.

Is Goodyear Tire & Rubber's Balance Sheet Risky?

As Goodyear Tire & Rubber 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). Goodyear Tire & Rubber has net debt of 3.56 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.41 times its interest expense is starting to become a concern for Goodyear Tire & Rubber, and be aware that lenders may place additional restrictions on the company as well.

We update our data on Goodyear Tire & Rubber every 24 hours, so you can always get our latest analysis of its financial health, here.

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 Goodyear Tire & Rubber has been paying a dividend for the past six years. The dividend has been quite stable over the past six 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 six-year period, the first annual payment was US$0.20 in 2013, compared to US$0.64 last year. Dividends per share have grown at approximately 21% per year over this time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

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. Over the past five years, it looks as though Goodyear Tire & Rubber's EPS have declined at around 20% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Goodyear Tire & Rubber's earnings per share, which support the dividend, have been anything but stable.

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. Goodyear Tire & Rubber gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Earnings per share are down, and to our mind Goodyear Tire & Rubber has not been paying a dividend long enough to demonstrate its resilience across economic cycles. Using these criteria, Goodyear Tire & Rubber looks quite suboptimal from a dividend investment perspective.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 9 analysts we track are forecasting for the future.

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.