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Is Royal Bank of Canada (TSE:RY) A Smart Pick For Income Investors?

Simply Wall St

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Dividend paying stocks like Royal Bank of Canada (TSE:RY) 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. 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.

With Royal Bank of Canada yielding 3.9% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. There are a few simple ways to reduce the risks of buying Royal Bank of Canada for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Royal Bank of Canada!

TSX:RY Historical Dividend Yield, July 9th 2019

Payout ratios

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. Royal Bank of Canada paid out 45% of its profit as dividends, over the trailing twelve month period. 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.

Consider getting our latest analysis on Royal Bank of Canada's financial position here.

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. Royal Bank of Canada has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During the past ten-year period, the first annual payment was CA$2.00 in 2009, compared to CA$4.08 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.4% a year over that 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

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. Earnings have grown at around 9.4% a year for the past five years, which is better than seeing them shrink! It's good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term - assuming earnings can be maintained, of course.

Conclusion

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. We're glad to see Royal Bank of Canada has a low payout ratio, as this suggests earnings are being reinvested in the business. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. Royal Bank of Canada fits all of our criteria, and we think it's an attractive dividend idea that would warrant further investigation.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 12 analysts we track are forecasting for Royal Bank of Canada 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.