Could Johnson & Johnson (NYSE:JNJ) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.
A 2.9% yield is nothing to get excited about, but investors probably think the long payment history suggests Johnson & Johnson has some staying power. The company also bought back stock equivalent to around 2.2% of market capitalisation this year. 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.
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. Johnson & Johnson paid out 60% of its profit as dividends, over the trailing twelve month period. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Johnson & Johnson paid out 53% 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.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Johnson & Johnson’s dividend 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$1.84 in 2009, compared to US$3.80 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.5% a year over that time.
Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.
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. Earnings have grown at around 4.4% a year for the past five years, which is better than seeing them shrink! Growth of 4.4% is relatively anaemic growth, which we wonder about. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.
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. First, we think Johnson & Johnson is paying out an acceptable percentage of its cashflow and profit. It hasn’t demonstrated a strong ability to grow earnings per share, but we like that the dividend payments have been fairly consistent. In sum, we find it hard to get excited about Johnson & Johnson from a dividend perspective. It’s not that we think it’s a bad business; just that there are other companies that perform better on these criteria.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 19 analysts we track are forecasting for Johnson & Johnson 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%.
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If you spot an error that warrants correction, please contact the editor at email@example.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.