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Three Things You Should Check Before Buying Avery Dennison Corporation (NYSE:AVY) For Its Dividend

Simply Wall St

Is Avery Dennison Corporation (NYSE:AVY) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

While Avery Dennison's 1.8% dividend yield is not the highest, we think its lengthy payment history is quite interesting. The company also bought back stock during the year, equivalent to approximately 4.0% of the company's market capitalisation at the time. There are a few simple ways to reduce the risks of buying Avery Dennison for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Avery Dennison!

NYSE:AVY Historical Dividend Yield, November 19th 2019

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Avery Dennison paid out 78% of its profit as dividends, over the trailing twelve month period. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Avery Dennison's cash payout ratio in the last year was 39%, which suggests dividends were well covered by cash generated by the business. It's positive to see that Avery Dennison's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Remember, you can always get a snapshot of Avery Dennison's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

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 Avery Dennison's dividend payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was US$1.64 in 2009, compared to US$2.32 last year. Dividends per share have grown at approximately 3.5% per year over this time. Avery Dennison's dividend payments have fluctuated, so it hasn't grown 3.5% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Avery Dennison has grown its earnings per share at 2.7% per annum over the past five years. Earnings are not growing quickly at all, and the company is paying out most of its profit as dividends. When the rate of return on reinvestment opportunities falls below a certain minimum level, companies often elect to pay a larger dividend instead. This is why many mature companies often have larger dividend yields.

Conclusion

To summarise, shareholders should always check that Avery Dennison's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Avery Dennison's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Avery Dennison out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 12 analysts we track are forecasting for Avery Dennison 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.