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Dividend paying stocks like KB Home (NYSE:KBH) 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.
A 1.4% yield is nothing to get excited about, but investors probably think the long payment history suggests KB Home has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 3.4% of KB Home's profits were paid out as dividends in the last 12 months. We'd say its dividends are thoroughly covered by earnings.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. KB Home's cash payout ratio in the last year was 26%, which suggests dividends were well covered by cash generated by the business. It's positive to see that KB Home'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 KB Home's financial position here.
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 KB Home's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.25 in 2009, compared to US$0.36 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.7% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see KB Home has grown its earnings per share at 44% per annum over the past five years. The company is only paying out a fraction of its earnings as dividends, and in the past been able to use the retained earnings to grow its profits rapidly - an ideal combination.
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 KB Home is paying out a low percentage of its earnings and cash flow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Overall we think KB Home scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 14 KB Home analysts we track are forecasting continued growth with our free report on 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 firstname.lastname@example.org. 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.