Dividend paying stocks like Wm Morrison Supermarkets PLC (LON:MRW) 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. 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.
A high yield and a long history of paying dividends is an appealing combination for Wm Morrison Supermarkets. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can reduce the risk of holding Wm Morrison Supermarkets for its dividend, and we'll focus on the most important aspects below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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. In the last year, Wm Morrison Supermarkets paid out 46% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 50% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Wm Morrison Supermarkets has available to meet other needs. 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.
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 Wm Morrison Supermarkets's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was UK£0.058 in 2010, compared to UK£0.088 last year. Dividends per share have grown at approximately 4.2% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.
Dividend Growth Potential
With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Wm Morrison Supermarkets has grown its earnings per share at 50% per annum over the past five 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.
To summarise, shareholders should always check that Wm Morrison Supermarkets'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 Wm Morrison Supermarkets 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, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Overall we think Wm Morrison Supermarkets is an interesting dividend stock, although it could be better.
Market movements attest to how highly valued a consistent dividend policy is to one to which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 1 warning sign for Wm Morrison Supermarkets that investors need to be conscious of moving forward.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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.
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