Is Cabot Corporation (NYSE:CBT) A Smart Choice For Dividend Investors?

Dividend paying stocks like Cabot Corporation (NYSE:CBT) 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.

A high yield and a long history of paying dividends is an appealing combination for Cabot. It would not be a surprise to discover that many investors buy it for the dividends. The company also returned around 8.7% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple analysis can reduce the risk of holding Cabot for its dividend, and we'll focus on the most important aspects below.

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Payout ratios

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. Looking at the data, we can see that 37% of Cabot's profits were paid out as dividends in the last 12 months. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. 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. The company paid out 82% 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 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.

Dividend Volatility

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. Cabot 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$0.72 in 2009, compared to US$1.40 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.9% 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

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Cabot has grown its earnings per share at 8.7% 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.

Conclusion

To summarise, shareholders should always check that Cabot'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 Cabot pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Overall we think Cabot 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 7 analysts we track are forecasting for Cabot for free with public analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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 editorial-team@simplywallst.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.