Today we'll take a closer look at Toll Brothers, Inc. (NYSE:TOL) 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. 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.
Some readers mightn't know much about Toll Brothers's 1.1% dividend, as it has only been paying distributions for the last three years. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. During the year, the company also conducted a buyback equivalent to around 4.3% of its market capitalisation. Some simple analysis can reduce the risk of holding Toll Brothers for its dividend, and we'll focus on the most important aspects below.
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. Toll Brothers paid out 9.2% of its profit as dividends, over the trailing twelve month period. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Toll Brothers's cash payout ratio last year was 10%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Toll Brothers's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Consider getting our latest analysis on Toll Brothers's financial position here.
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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past three-year period, the first annual payment was US$0.32 in 2016, compared to US$0.44 last year. This works out to be a compound annual growth rate (CAGR) of approximately 11% a year over that time.
Toll Brothers 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
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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Toll Brothers has grown its earnings per share at 36% per annum over the past five years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.
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. It's great to see that Toll Brothers is paying out a low percentage of its earnings and cash flow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. All things considered, Toll Brothers looks like a strong prospect. At the right valuation, it could be something special.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 17 analysts we track are forecasting for Toll Brothers for free with public 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 email@example.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.