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MSC Industrial Direct Co., Inc.'s (NYSE:MSM) 3.4% Dividend Yield Looks Pretty Interesting

Simply Wall St

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Is MSC Industrial Direct Co., Inc. (NYSE:MSM) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

In this case, MSC Industrial Direct likely looks attractive to investors, given its 3.4% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock equivalent to around 2.9% 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.

Explore this interactive chart for our latest analysis on MSC Industrial Direct!

NYSE:MSM Historical Dividend Yield, July 1st 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, MSC Industrial Direct paid out 46% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. MSC Industrial Direct paid out 50% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. 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.

Remember, you can always get a snapshot of MSC Industrial Direct'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 MSC Industrial Direct's dividend payments. During the past ten-year period, the first annual payment was US$0.80 in 2009, compared to US$2.52 last year. Dividends per share have grown at approximately 12% per year over this time.

It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but MSC Industrial Direct has done it, which we really like.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. MSC Industrial Direct has grown its earnings per share at 7.0% per annum over the past five years. Earnings per share have been growing at a credible rate. What's more, the payout ratio is reasonable and provides some protection to the dividend, or even the potential to increase it.

Conclusion

To summarise, shareholders should always check that MSC Industrial Direct's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that MSC Industrial Direct pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. Overall we think MSC Industrial Direct is an interesting dividend stock, although it could be better.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 16 analysts we track are forecasting for MSC Industrial Direct 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 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.