Today we'll take a closer look at Eaton Corporation plc (NYSE:ETN) 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.
With Eaton yielding 3.0% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock equivalent to around 4.2% of market capitalisation this year. Some simple analysis can reduce the risk of holding Eaton for its dividend, and we'll focus on the most important aspects below.
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. In the last year, Eaton paid out 49% 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. Besides, if reinvestment opportunities dry up, the company has room to increase the 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. Of the free cash flow it generated last year, Eaton paid out 44% as dividends, suggesting the dividend is affordable. 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.
Consider getting our latest analysis on Eaton's financial position here.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Eaton has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$1.00 in 2010, compared to US$2.84 last year. This works out to be a compound annual growth rate (CAGR) of approximately 11% a year over that time.
With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.
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. Earnings have grown at around 7.5% a year for the past five years, which is better than seeing them shrink! 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 Eaton's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Eaton is paying out a low percentage of its earnings and cash flow. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. All things considered, Eaton looks like a strong prospect. At the right valuation, it could be something special.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 21 Eaton analysts we track are forecasting continued growth with our free report on 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 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.
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