Dividend paying stocks like NewMarket Corporation (NYSE:NEU) 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. 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 1.6% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, NewMarket could have potential. The company also bought back stock equivalent to around 2.1% of market capitalisation this year. There are a few simple ways to reduce the risks of buying NewMarket for its dividend, and we’ll go through these 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. 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 31% of NewMarket’s profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. NewMarket paid out a conservative 35% of its free cash flow as dividends last year. It’s positive to see that NewMarket’s dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
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 NewMarket’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 US$0.80 in 2009, compared to US$7.60 last year. This works out to be a compound annual growth rate (CAGR) of approximately 25% a year over that time.
It’s rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but NewMarket has done it, which we really like.
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. Earnings have grown at around 4.7% a year for the past five years, which is better than seeing them shrink! A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?
To summarise, shareholders should always check that NewMarket’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that NewMarket has low and conservative payout ratios. Second, it has a limited history of earnings per share growth, but at least the dividends have been relatively stable. NewMarket performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.
Are management backing themselves to deliver performance? Check their shareholdings in NewMarket in our latest insider ownership analysis.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.