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Something To Consider Before Buying Essential Utilities, Inc. (NYSE:WTRG) For The 2.1% Dividend

Simply Wall St

Is Essential Utilities, Inc. (NYSE:WTRG) 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 your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

A 2.1% yield is nothing to get excited about, but investors probably think the long payment history suggests Essential Utilities has some staying power. Some simple research can reduce the risk of buying Essential Utilities for its dividend - read on to learn more.

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NYSE:WTRG Historical Dividend Yield, March 10th 2020

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 87% of Essential Utilities's profits were paid out as dividends in the last 12 months. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a 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. Last year, Essential Utilities paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is Essential Utilities's Balance Sheet Risky?

As Essential Utilities has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) 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. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With net debt of 2.37 times its EBITDA, Essential Utilities has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 2.89 times its interest expense, Essential Utilities's interest cover is starting to look a bit thin.

Consider getting our latest analysis on Essential Utilities'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. Essential Utilities has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$0.43 in 2010, compared to US$0.94 last year. Dividends per share have grown at approximately 8.1% per year over this time.

Businesses that can grow their dividends at a decent rate and maintain a stable payout can generate substantial wealth for shareholders over the long term.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. In the last five years, Essential Utilities's earnings per share have shrunk at approximately 2.9% per annum. 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.

We'd also point out that Essential Utilities issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. It's not great to see earnings per share shrinking. The dividends have been relatively consistent, but we wonder for how much longer this will be true. With this information in mind, we think Essential Utilities may not be an ideal dividend stock.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Case in point: We've spotted 2 warning signs for Essential Utilities (of which 1 is a bit concerning!) you should know about.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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.

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. Thank you for reading.