Something To Consider Before Buying Travis Perkins plc (LON:TPK) For The 3.0% Dividend

Could Travis Perkins plc (LON:TPK) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

A 3.0% yield is nothing to get excited about, but investors probably think the long payment history suggests Travis Perkins has some staying power. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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 158% of Travis Perkins'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. Travis Perkins paid out 67% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Travis Perkins 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. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

We update our data on Travis Perkins every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

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 Travis Perkins's dividend 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 UK£0.10 in 2010, compared to UK£0.47 last year. Dividends per share have grown at approximately 17% per year over this time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

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. Travis Perkins's earnings per share have shrunk at 23% a year over the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

To summarise, shareholders should always check that Travis Perkins's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. 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, Travis Perkins 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.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 16 analysts we track are forecasting for the future.

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 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.

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. Thank you for reading.