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Would Telephone and Data Systems, Inc. (NYSE:TDS) Be Valuable To Income Investors?

Simply Wall St

Today we'll take a closer look at Telephone and Data Systems, Inc. (NYSE:TDS) 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 stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

While Telephone and Data Systems's 2.5% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

NYSE:TDS Historical Dividend Yield, October 23rd 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. Looking at the data, we can see that 47% of Telephone and Data Systems's profits were paid out as dividends in the last 12 months. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while Telephone and Data Systems pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

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 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 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 1.42 times its EBITDA, which we think is not too troublesome.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 1.48 times its interest expense, Telephone and Data Systems's interest cover is starting to look a bit thin.

Remember, you can always get a snapshot of Telephone and Data Systems's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. 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$0.38 in 2009, compared to US$0.66 last year. Dividends per share have grown at approximately 5.8% per year over this time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

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. Telephone and Data Systems's EPS are effectively flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. Telephone and Data Systems is paying out less than half of its earnings, which we like. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.

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. Telephone and Data Systems has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Second, earnings growth is pretty limited, but at least the dividends have been relatively stable. 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 that are growing earnings tend to be the best dividend stocks over the long term. See what the 4 analysts we track are forecasting for Telephone and Data Systems for free with public analyst estimates for the company.

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