Dividend paying stocks like Sanofi (EPA:SAN) 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. 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.
With Sanofi yielding 3.5% 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. There are a few simple ways to reduce the risks of buying Sanofi for its dividend, and we’ll go through these 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. Looking at the data, we can see that 121% of Sanofi’s profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. The company paid out 76% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It’s disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Sanofi fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we’d be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.
Is Sanofi’s Balance Sheet Risky?
As Sanofi’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). Sanofi has net debt of 1.80 times its EBITDA, which is generally an okay level of debt for most companies.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. Sanofi has interest cover of more than 12 times its interest expense, which we think is quite strong.
Remember, you can always get a snapshot of Sanofi’s latest financial position, by checking our visualisation of its financial health.
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. Sanofi has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 €2.20 in 2010, compared to €3.07 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.4% a year over that time.
Slow and steady dividend growth might not sound that exciting, but dividends have been stable for ten years, which we think is seriously impressive.
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. Sanofi’s EPS are effectively flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company’s dividends could be eroded by inflation.
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. We’re a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, earnings per share have actually shrunk, but at least the dividends have been relatively stable. Overall, Sanofi falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting 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 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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