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What To Know Before Buying United Parcel Service, Inc. (NYSE:UPS) For Its Dividend

Simply Wall St

Is United Parcel Service, Inc. (NYSE:UPS) 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 high yield and a long history of paying dividends is an appealing combination for United Parcel Service. 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 0.8% of market capitalisation this year. There are a few simple ways to reduce the risks of buying United Parcel Service for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on United Parcel Service!

NYSE:UPS Historical Dividend Yield, January 17th 2020

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. 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 66% of United Parcel Service's profits were paid out as dividends in the last 12 months. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. United Parcel Service paid out 110% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. While United Parcel Service's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were United Parcel Service to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Remember, you can always get a snapshot of United Parcel Service'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. For the purpose of this article, we only scrutinise the last decade of United Parcel Service's dividend payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$1.80 in 2010, compared to US$3.84 last year. Dividends per share have grown at approximately 7.9% 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

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. Earnings have grown at around 4.4% a year for the past five years, which is better than seeing them shrink! 4.4% per annum is not a particularly high rate of growth, which we find curious. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.

Conclusion

To summarise, shareholders should always check that United Parcel Service's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. United Parcel Service 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. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than United Parcel Service out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 23 United Parcel Service analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.