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Is W.W. Grainger, Inc. (NYSE:GWW) A Smart Pick For Income Investors?

Simply Wall St

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Today we'll take a closer look at W.W. Grainger, Inc. (NYSE:GWW) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

While W.W. Grainger's 2.1% dividend yield is not the highest, we think its lengthy payment history is quite interesting. The company also bought back stock equivalent to around 1.7% of market capitalisation this year. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on W.W. Grainger!

NYSE:GWW Historical Dividend Yield, June 18th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. W.W. Grainger paid out 38% of its profit as dividends, over the trailing twelve month period. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, W.W. Grainger paid out 39% as dividends, suggesting the dividend is affordable. It's positive to see that W.W. Grainger'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 W.W. Grainger'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. For the purpose of this article, we only scrutinise the last decade of W.W. Grainger's dividend payments. 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 ten-year period, the first annual payment was US$1.84 in 2009, compared to US$5.76 last year. This works out to be a compound annual growth rate (CAGR) of approximately 12% a year over that time.

It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but W.W. Grainger has done it, which we really like.

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 4.7% a year for the past five years, which is better than seeing them shrink! A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.

Conclusion

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 W.W. Grainger is paying out a low percentage of its earnings and cash flow. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. All things considered, W.W. Grainger looks like a strong prospect. At the right valuation, it could be something special.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 22 analysts we track are forecasting for W.W. Grainger 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%.

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.