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Is Telephone and Data Systems, Inc. (NYSE:TDS) 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.
In this case, Telephone and Data Systems likely looks attractive to investors, given its 3.5% 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 during the year, equivalent to approximately 1.4% of the company's market capitalisation at the time. Some simple analysis can reduce the risk of holding Telephone and Data Systems for its dividend, and we'll focus on the most important aspects below.
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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Telephone and Data Systems paid out 62% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.
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, Telephone and Data Systems paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is Telephone and Data Systems's Balance Sheet Risky?
As Telephone and Data Systems has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). Telephone and Data Systems has net debt of 1.65 times its EBITDA, which we think is not too troublesome.
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 1.40 times its interest expense is starting to become a concern for Telephone and Data Systems, and be aware that lenders may place additional restrictions on the company as well.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Telephone and Data Systems's dividend 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$0.40 in 2010, compared to US$0.68 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.6% 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
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Telephone and Data Systems has grown its earnings per share at 16% per annum over the past five years. Telephone and Data Systems's earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.
To summarise, shareholders should always check that Telephone and Data Systems's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Telephone and Data Systems gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Telephone and Data Systems out there.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. However, there are other things to consider for investors when analysing stock performance. To that end, Telephone and Data Systems has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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.
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.