Tread With Caution Around GlaxoSmithKline Pharmaceuticals Limited's (NSE:GLAXO) 1.3% Dividend Yield

Could GlaxoSmithKline Pharmaceuticals Limited (NSE:GLAXO) 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. 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.

A slim 1.3% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, GlaxoSmithKline Pharmaceuticals could have potential. There are a few simple ways to reduce the risks of buying GlaxoSmithKline Pharmaceuticals for its dividend, and we'll go through these below.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. GlaxoSmithKline Pharmaceuticals paid out 374% of its profit as dividends, over the trailing twelve month period. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 101%, GlaxoSmithKline Pharmaceuticals' dividend payments are poorly covered by cash flow. Cash is slightly more important than profit from a dividend perspective, but given GlaxoSmithKline Pharmaceuticals' payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

While the above analysis focuses on dividends relative to a company's earnings, we do note GlaxoSmithKline Pharmaceuticals' strong net cash position, which will let it pay larger dividends for a time, should it choose.

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

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. For the purpose of this article, we only scrutinise the last decade of GlaxoSmithKline Pharmaceuticals' dividend payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was ₹15.0 in 2010, compared to ₹20.0 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.9% 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.

Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? GlaxoSmithKline Pharmaceuticals' EPS have fallen by approximately 35% per year during the past three 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

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. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. Using these criteria, GlaxoSmithKline Pharmaceuticals looks quite suboptimal from a dividend investment perspective.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. However, there are other things to consider for investors when analysing stock performance. For instance, we've picked out 3 warning signs for GlaxoSmithKline Pharmaceuticals that investors should take into consideration.

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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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