Carnival plc (LON:CCL) Is Yielding 3.9% - But Is It A Buy?

Dividend paying stocks like Carnival plc (LON:CCL) tend to be popular with investors, and for good reason - some research shows that a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

With a nine-year payment history and a 3.9% yield, many investors probably find Carnival intriguing. The yield does look pretty interesting. It also bought back stock during the year, equivalent to approximately 4.3% of the company's market capitalisation at the time. 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.

Explore this interactive chart for our latest analysis on Carnival!

Payout ratios

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. Carnival paid out 45% of its profit as dividends, over the trailing twelve month period. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Plus, there is room to increase 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. Carnival paid out 456% of its free cash flow last year, which we think is a risk if cash flows do not improve. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely.

Is Carnival's Balance Sheet Risky?

As Carnival has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks.

A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. Carnival has net debt of 2.04 times its earnings before interest, tax, depreciation, and amortisation (EBITDA). Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Carnival has interest cover of more than 12 times its interest expense, which we think is quite strong.

Remember, you can always get a snapshot of Carnival's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

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. The first recorded dividend for Carnival, in the last decade, was nine years ago. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past nine-year period, the first annual payment was US$0.40 in 2010, compared to US$2.00 last year. This works out to be a compound annual growth rate (CAGR) of approximately 20% a year over that time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Carnival has grown its earnings per share at 26% per annum over the past five years. With high earnings per share growth in recent times and a modest payout ratio, we think this is an attractive combination if earnings can be reinvested to generate further growth.

Conclusion

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, the company has a conservative payout ratio, although we'd note that its cashflow in the past year was substantially lower than its reported profit. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Ultimately, Carnival comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 7 analysts we track are forecasting for Carnival 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 editorial-team@simplywallst.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.