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Is Sirius XM Holdings Inc. (NASDAQ:SIRI) A Smart Choice For Dividend Investors?

Simply Wall St

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Today we'll take a closer look at Sirius XM Holdings Inc. (NASDAQ:SIRI) 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. 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 only a three-year payment history, and a 0.9% yield, investors probably think Sirius XM Holdings is not much of a dividend stock. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. The company also bought back stock equivalent to around 6.9% of market capitalisation this year. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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NasdaqGS:SIRI Historical Dividend Yield, June 5th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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, Sirius XM Holdings paid out 20% of its profit as dividends. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Sirius XM Holdings's cash payout ratio last year was 13%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. 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.

Is Sirius XM Holdings's Balance Sheet Risky?

As Sirius XM Holdings has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. Sirius XM Holdings has net debt of more than 3x its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 5.31 times its interest expense appears reasonable for Sirius XM Holdings, although we're conscious that even high interest cover doesn't make a company bulletproof.

Consider getting our latest analysis on Sirius XM Holdings'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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past three-year period, the first annual payment was US$0.04 in 2016, compared to US$0.048 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.6% a year over that time.

Sirius XM Holdings has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Sirius XM Holdings has grown its earnings per share at 31% per annum over the past five years. The company is only paying out a fraction of its earnings as dividends, and in the past been able to use the retained earnings to grow its profits rapidly - an ideal combination.

Conclusion

To summarise, shareholders should always check that Sirius XM Holdings'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 Sirius XM Holdings has low and conservative payout ratios. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Overall we think Sirius XM Holdings scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 13 analysts we track are forecasting for Sirius XM Holdings 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.