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Three Things You Should Check Before Buying Gilead Sciences, Inc. (NASDAQ:GILD) For Its Dividend

Simply Wall St

Could Gilead Sciences, Inc. (NASDAQ:GILD) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. 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.

With a five-year payment history and a 3.8% yield, many investors probably find Gilead Sciences intriguing. It sure looks interesting on these metrics - but there's always more to the story . During the year, the company also conducted a buyback equivalent to around 2.8% of its market capitalisation. There are a few simple ways to reduce the risks of buying Gilead Sciences for its dividend, and we'll go through these below.

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NasdaqGS:GILD Historical Dividend Yield, December 9th 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. 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, Gilead Sciences paid out 116% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Gilead Sciences's cash payout ratio in the last year was 39%, which suggests dividends were well covered by cash generated by the business. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Gilead Sciences fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is Gilead Sciences's Balance Sheet Risky?

As Gilead Sciences's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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. Gilead Sciences has net debt of 0.22 times its EBITDA, which is generally an okay level of debt for most companies.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Gilead Sciences has EBIT of 5.11 times its interest expense, which we think is adequate.

Remember, you can always get a snapshot of Gilead Sciences'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. Looking at the data, we can see that Gilead Sciences has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$1.72 in 2014, compared to US$2.52 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.9% a year over that time.

The dividend has been growing at a reasonable rate, which we like. We're conscious though that one of the best ways to detect a multi-decade consistent dividend-payer, is to watch a company pay dividends for 20 years - a distinction Gilead Sciences has not achieved yet.

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. While there may be fluctuations in the past , Gilead Sciences's earnings per share have basically not grown from where they were five years ago. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. Still, the company has struggled to grow its EPS, and currently pays out 116% of its earnings. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.

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. We're not keen on the fact that Gilead Sciences paid out such a high percentage of its income, although its cashflow is in better shape. Second, the company has not been able to generate earnings growth, and its history of dividend payments is shorter than we consider ideal (from a reliability perspective). In sum, we find it hard to get excited about Gilead Sciences from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 25 Gilead Sciences analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.

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