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Dividend paying stocks like Brown-Forman Corporation (NYSE:BF.B) 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. 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.
A 1.2% yield is nothing to get excited about, but investors probably think the long payment history suggests Brown-Forman has some staying power. The company also bought back stock equivalent to around 0.8% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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, Brown-Forman paid out 39% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Brown-Forman paid out 57% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into 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.
Is Brown-Forman's Balance Sheet Risky?
As Brown-Forman has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. Brown-Forman has net debt of 2.05 times its earnings before interest, tax, depreciation, and amortisation (EBITDA). Using debt can accelerate business growth, but also increases the risks.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 13.17 times its interest expense, Brown-Forman's interest cover is quite strong - more than enough to cover the interest expense.
We update our data on Brown-Forman every 24 hours, so you can always get our latest analysis of its financial health, here.
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. For the purpose of this article, we only scrutinise the last decade of Brown-Forman'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$0.31 in 2009, compared to US$0.66 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.0% a year over that 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. Brown-Forman has grown its earnings per share at 8.1% per annum over the past five years. Earnings per share have been growing at a credible rate. What's more, the payout ratio is reasonable and provides some protection to the dividend, or even the potential to increase it.
To summarise, shareholders should always check that Brown-Forman's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Above all, we're glad to see that Brown-Forman pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. Next, growing earnings per share and steady dividend payments is a great combination. Brown-Forman 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.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 13 analysts we track are forecasting for Brown-Forman for free with public analyst estimates for the company.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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 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. Thank you for reading.