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Is Seagate Technology plc (NASDAQ:STX) A Great Dividend Stock?

Simply Wall St

Today we'll take a closer look at Seagate Technology plc (NASDAQ:STX) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

In this case, Seagate Technology likely looks attractive to investors, given its 5.5% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. The company also bought back stock equivalent to around 7.5% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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NasdaqGS:STX Historical Dividend Yield, August 18th 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. In the last year, Seagate Technology paid out 35% 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. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Seagate Technology paid out 62% 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.

Consider getting our latest analysis on Seagate Technology'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. Seagate Technology has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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$0.48 in 2009, compared to US$2.52 last year. Dividends per share have grown at approximately 18% per year over this time. Seagate Technology's dividend payments have fluctuated, so it hasn't grown 18% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Seagate Technology has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

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. Earnings have grown at around 8.9% a year for the past five years, which is better than seeing them shrink! 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 Seagate Technology's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Seagate Technology's dividend payout ratios are within normal bounds, although we note its cash flow is not as strong as the income statement would suggest. Unfortunately, the company has not been able to generate earnings per share growth, and cut its dividend at least once in the past. Overall we think Seagate Technology is an interesting dividend stock, although it could be better.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 25 Seagate Technology analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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 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.