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This article first appeared on Simply Wall St News.
An old Wall Street proverb says that "big bases create big breakouts." It is hard to find a better example than United Parcel Service, Inc. (NYSE: UPS), which rallied over 100% from the baseline after ranging from several years.
The stock added 25% in 2021 and looks to end the year on a high note. In this article, we'll take a look at its dividend that pays an above-average yield at a stable pace.
Year-to-date, UPS has outperformed the main competition and the broad market, as is visible from the following chart.
However, it seems like the hedge funds are withdrawing attention from the stock. By the end of June, 52 hedge funds were holding UPS, while there were 42 by the end of Q3.
Furthermore, institutions seem to disagree about their prospects. Two weeks ago, Deutsche Bank downgraded the stock to Hold from Buy, arguing that dividend stocks underperform in a rising interest rate environment. On Wednesday, the FED announced 3 possible interest rate hikes in 2022.
Meanwhile, Citi upgraded it to Buy from Neutral, quoting strong pricing power and a recent union contract that should help boost the margins. Citi sees the price target at US$245.
Examining the Dividend
While United Parcel Service's 2.0% dividend yield is not the highest, it is still one of the best in the industry. There are a few simple ways to reduce the risks of buying United Parcel Service for its dividend, and we'll go through these below.
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, the dividend might become unsustainable. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. United Parcel Service paid out 55% of its profit as dividends over the trailing twelve-month period. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders but does limit the capital retained in the business.
We also measure dividends paid against a company's levered free cash flow to see if enough cash was generated to cover the dividend. United Parcel Service paid out a conservative 42% of its free cash flow as dividends last year. 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 United Parcel Service every 24 hours, so you can always get our latest analysis of its financial health, here.
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.
Looking back, 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 10-year period, the first annual payment was US$2.1 in 2011, compared to US$4.1 last year. Dividends per share have grown at approximately 7.0% per year over this time.
Businesses that can grow their dividends at a decent rate and maintain a stable payout can generate substantial wealth for shareholders over the long term.
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. United Parcel Service has grown its earnings per share at 5.7% per annum over the past five years. The rate at which earnings have grown is quite decent, and by paying out more than half of its earnings as dividends, the company is striking a reasonable balance between reinvestment and returns to shareholders.
When we look at a dividend stock, we need to form a judgment 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.
United Parcel Service's payout ratios are within a normal range for the average corporation, and we like that its cash flow was more robust than reported profits. While earnings growth has been mediocre, the dividend has been relatively stable.
Overall, UPS scores reasonably well in our dividend evaluation. Although looking at the 3 dividend hikes scheduled for the next 12 months, we need to look beyond the yield before jumping in the investment.
Investors need to consider a host of other factors, apart from dividend payments, when analyzing a company. Just as an example, we've come across 2 warning signs for United Parcel Service you should be aware of, and 1 of them doesn't sit too well with us.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.