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Today we'll take a closer look at National Oilwell Varco, Inc. (NYSE:NOV) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
Investors might not know much about National Oilwell Varco's dividend prospects, even though it has been paying dividends for the last nine years and offers a 0.8% yield. While the yield may not look too great, the relatively long payment history is interesting. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this 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. So we need to be form a view on if a company's dividend is sustainable, relative to its net profit after tax. Although National Oilwell Varco pays a dividend, it was loss-making during the past year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.
With a loss in the last year, it becomes even more important to evaluate if the company is generating enough cash flow to pay its dividend and meet its obligations. National Oilwell Varco's cash payout ratio last year was 21%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout.
Is National Oilwell Varco's Balance Sheet Risky?
Given National Oilwell Varco is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). National Oilwell Varco has net debt of 2.40 times its earnings before interest, tax, depreciation, and amortisation (EBITDA). Using debt can accelerate business growth, but also increases the risks.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of less than 5x its interest expense is starting to become a concern for National Oilwell Varco, and be aware that lenders may place additional restrictions on the company as well.
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. Looking at the last decade of data, we can see that National Oilwell Varco paid its first dividend at least nine years ago. The dividend has been quite stable over the past nine years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past nine-year period, the first annual payment was US$0.40 in 2010, compared to US$0.20 last year. The dividend has shrunk at around -7.4% a year during that period.
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. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. It's not great to see that National Oilwell Varco's have fallen at approximately 42% over the past five years. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.
To summarise, shareholders should always check that National Oilwell Varco's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're not keen on the fact that National Oilwell Varco paid out such a high percentage of its income, although its cashflow is in better shape. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. In summary, National Oilwell Varco has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.
Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 26 analysts we track are forecasting for the future.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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 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.