Dividend paying stocks like STMicroelectronics N.V. (EPA:STM) 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 1.3% yield is nothing to get excited about, but investors probably think the long payment history suggests STMicroelectronics has some staying power. The company also bought back stock during the year, equivalent to approximately 1.3% of the company’s market capitalisation at the time. Some simple analysis can reduce the risk of holding STMicroelectronics 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. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 19% of STMicroelectronics’s profits were paid out as dividends in the last 12 months. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. STMicroelectronics paid out 52% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. 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. STMicroelectronics has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.12 in 2009, compared to US$0.24 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.2% a year over that 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.
A reasonable rate of dividend growth is good to see, but we’re wary that the dividend history is not as solid as we’d like, having been cut at least once.
Dividend Growth Potential
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the 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 STMicroelectronics has grown its earnings per share at 59% per annum over the past five years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.
Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Above all, we’re glad to see that STMicroelectronics pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered – having cut its dividend at least once in the past. Overall we think STMicroelectronics is an interesting dividend stock, although it could be better.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 19 STMicroelectronics analysts we track are forecasting continued growth with our free report on analyst estimates for the company.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
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