U.S. Markets closed

What To Know Before Buying Caterpillar Inc. (NYSE:CAT) For Its Dividend

Simply Wall St

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Could Caterpillar Inc. (NYSE:CAT) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

With Caterpillar yielding 3.1% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. The company also bought back stock equivalent to around 5.1% of market capitalisation this year. 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

NYSE:CAT Historical Dividend Yield, June 21st 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Caterpillar paid out 32% of its profit as dividends, over the trailing twelve month period. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Caterpillar paid out a conservative 49% of its free cash flow as dividends last year. 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.

Is Caterpillar's Balance Sheet Risky?

As Caterpillar has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. Caterpillar has net debt of 2.65 times its earnings before interest, tax, depreciation, and amortisation (EBITDA). Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Caterpillar has interest cover of more than 12 times its interest expense, which we think is quite strong.

Remember, you can always get a snapshot of Caterpillar'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 Caterpillar's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$1.68 in 2009, compared to US$4.12 last year. Dividends per share have grown at approximately 9.4% per year over this time.

Dividends have grown at a reasonable rate over this period, and without any major cuts in the payment over time, we think this is an attractive combination.

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. It's good to see Caterpillar has been growing its earnings per share at 13% a year over the past 5 years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.

Conclusion

To summarise, shareholders should always check that Caterpillar's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Caterpillar is paying out a low percentage of its earnings and cash flow. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. Overall, we think there are a lot of positives to Caterpillar from a dividend perspective.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 20 analysts we track are forecasting for Caterpillar 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%.

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.