Today we'll take a closer look at NetApp, Inc. (NASDAQ:NTAP) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
Investors might not know much about NetApp's dividend prospects, even though it has been paying dividends for the last six years and offers a 2.3% yield. While the yield may not look too great, the relatively long payment history is interesting. The company also bought back stock during the year, equivalent to approximately 11% of the company's market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
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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. 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. NetApp paid out 35% 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. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. NetApp's cash payout ratio last year was 17%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that NetApp'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.
Consider getting our latest analysis on NetApp's financial position 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. Looking at the data, we can see that NetApp has been paying a dividend for the past six years. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past six-year period, the first annual payment was US$0.60 in 2013, compared to US$1.60 last year. Dividends per share have grown at approximately 18% per year over this 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
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. It's good to see NetApp has been growing its earnings per share at 23% a year over the past 5 years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.
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 NetApp has low and conservative payout ratios. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Overall we think NetApp scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 27 analysts we track are forecasting for NetApp for free with public analyst estimates for the company.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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 firstname.lastname@example.org. 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.