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Dividend paying stocks like Suncor Energy Inc. (TSE:SU) 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. 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 high yield and a long history of paying dividends is an appealing combination for Suncor Energy. It would not be a surprise to discover that many investors buy it for the dividends. The company also bought back stock equivalent to around 4.6% 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 typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable – hardly an ideal situation. 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. In the last year, Suncor Energy paid out 61% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Of the free cash flow it generated last year, Suncor Energy paid out 38% as dividends, suggesting the dividend is affordable. 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. Suncor Energy has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During the past ten-year period, the first annual payment was CA$0.20 in 2009, compared to CA$1.68 last year. Dividends per share have grown at approximately 24% per year over this time.
With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient’s purchasing power. While there may be fluctuations in the past , Suncor Energy’s earnings per share have basically not grown from where they were five years ago. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation.
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. Suncor Energy’s payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Second, earnings per share have actually shrunk, but at least the dividends have been relatively stable. In sum, we find it hard to get excited about Suncor Energy 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.
Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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 firstname.lastname@example.org. 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.