Dividend paying stocks like Toll Brothers, Inc. (NYSE:TOL) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. 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.
Some readers mightn't know much about Toll Brothers's 1.9% dividend, as it has only been paying distributions for the last three years. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. The company also returned around 22% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Remember though, given the recent drop in its share price, Toll Brothers's yield will look higher, even though the market may now be expecting a decline in its long-term prospects. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, Toll Brothers paid out 12% of its profit as dividends. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Toll Brothers's cash payout ratio in the last year was 38%, which suggests dividends were well covered by cash generated by the business. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.
We update our data on Toll Brothers every 24 hours, so you can always get our latest analysis of its financial health, here.
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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past three-year period, the first annual payment was US$0.32 in 2017, compared to US$0.44 last year. This works out to be a compound annual growth rate (CAGR) of approximately 11% a year over that time.
Toll Brothers has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.
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. It's good to see Toll Brothers has been growing its earnings per share at 14% a year over the past five years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.
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. It's great to see that Toll Brothers is paying out a low percentage of its earnings and cash flow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Toll Brothers performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. To that end, Toll Brothers has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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 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.
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