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Dividend paying stocks like Aristocrat Leisure Limited (ASX:ALL) 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.
While Aristocrat Leisure’s 1.6% dividend yield is not the highest, we think its lengthy payment history is quite interesting. That said, the recent jump in the share price will make Aristocrat Leisure’s dividend yield look smaller, even though the company prospects could be improving. 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.
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. Aristocrat Leisure paid out 49% of its profit as dividends, over the trailing twelve month period. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. 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. Aristocrat Leisure paid out a conservative 30% of its free cash flow as dividends last year. It’s positive to see that Aristocrat Leisure’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.
Consider getting our latest analysis on Aristocrat Leisure’s financial position here.
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. Aristocrat Leisure has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was AU$0.09 in 2009, compared to AU$0.49 last year. Dividends per share have grown at approximately 18% per year over this time. The dividends haven’t grown at precisely 18% every year, but this is a useful way to average out the historical rate of growth.
It’s not great to see that the payment has been cut in the past. We’re generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.
Dividend Growth Potential
With a relatively unstable dividend, it’s even more important to evaluate if earnings per share (EPS) are growing – it’s not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. It’s good to see Aristocrat Leisure has been growing its earnings per share at 37% a year over the past 5 years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Firstly, we like that Aristocrat Leisure has low and conservative payout ratios. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Aristocrat Leisure 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.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 15 analysts we track are forecasting for Aristocrat Leisure for free with public 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%.
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.
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.