Dividend paying stocks like Iberdrola, S.A. (BME:IBE) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.
A high yield and a long history of paying dividends is an appealing combination for Iberdrola. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock during the year, equivalent to approximately 3.5% of the company's market capitalisation at the time. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. Iberdrola paid out 76% of its profit as dividends, over the trailing twelve month period. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Iberdrola paid out 24% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's positive to see that Iberdrola'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.
We update our data on Iberdrola every 24 hours, so you can always get our latest analysis of its financial health, here.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Iberdrola's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was €0.3 in 2011, compared to €0.4 last year. Dividends per share have grown at approximately 2.3% per year over this 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.
We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.
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? Iberdrola has grown its earnings per share at 8.4% per annum over the past five years. EPS have been growing at a reasonable rate, although with most of the profits being paid out to shareholders, we question if the company will be able to keep growing its dividends in the future.
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. Iberdrola's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. 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. Overall we think Iberdrola is an interesting dividend stock, although it could be better.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 2 warning signs for Iberdrola that investors need to be conscious of moving forward.
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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