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What Makes Cummins Inc. (NYSE:CMI) A Great Dividend Stock?

Simply Wall St

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Dividend paying stocks like Cummins Inc. (NYSE:CMI) 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 2.9% yield is nothing to get excited about, but investors probably think the long payment history suggests Cummins has some staying power. The company also bought back stock during the year, equivalent to approximately 4.3% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying Cummins for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

NYSE:CMI Historical Dividend Yield, May 30th 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. 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. In the last year, Cummins paid out 29% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Plus, there is room to increase the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Cummins paid out 35% as dividends, suggesting the dividend is affordable. It's positive to see that Cummins'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.

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

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 Cummins'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$0.70 in 2009, compared to US$4.56 last year. This works out to be a compound annual growth rate (CAGR) of approximately 21% a year over that time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Cummins has grown its earnings per share at 14% per annum over the past five 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

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. It's great to see that Cummins is paying out a low percentage of its earnings and cash flow. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Cummins has met all of our criteria, including having strong cash flow that covers the dividend. We definitely think it would be worthwhile looking closer.

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