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Is Valvoline Inc. (NYSE:VVV) A Smart Pick For Income Investors?

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Simply Wall St
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Is Valvoline Inc. (NYSE:VVV) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With only a three-year payment history, and a 2.1% yield, investors probably think Valvoline is not much of a dividend stock. 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 2.6% of its market capitalisation to shareholders in the form of stock buybacks over the past year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Valvoline!

NYSE:VVV Historical Dividend Yield, January 21st 2020
NYSE:VVV Historical Dividend Yield, January 21st 2020

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 39% of Valvoline's profits were paid out as dividends in the last 12 months. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Valvoline paid out a conservative 37% 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.

Is Valvoline's Balance Sheet Risky?

As Valvoline 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 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. With net debt of 2.94 times its EBITDA, Valvoline has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 4.67 times its interest expense is starting to become a concern for Valvoline, and be aware that lenders may place additional restrictions on the company as well.

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

Dividend Volatility

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$0.20 in 2017, compared to US$0.45 last year. This works out to be a compound annual growth rate (CAGR) of approximately 32% a year over that time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

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. Earnings have grown at around 5.5% a year for the past five years, which is better than seeing them shrink! It's good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term - assuming earnings can be maintained, of course.

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. Firstly, we like that Valvoline has low and conservative payout ratios. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we'd like. Valvoline has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 9 analysts we track are forecasting for Valvoline for free with public 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.

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. Thank you for reading.