The board of British American Tobacco p.l.c. (LON:BATS) has announced that it will be increasing its dividend on the 4th of May to UK£0.54. The announced payment will take the dividend yield to 6.8%, which is in line with the average for the industry.
British American Tobacco's Dividend Is Well Covered By Earnings
We like to see a healthy dividend yield, but that is only helpful to us if the payment can continue. Before this announcement, British American Tobacco was paying out 73% of earnings, but a comparatively small 55% of free cash flows. In general, cash flows are more important than earnings, so we are comfortable that the dividend will be sustainable going forward, especially with so much cash left over for reinvestment.
Looking forward, earnings per share is forecast to rise by 10.2% over the next year. If the dividend continues along recent trends, we estimate the payout ratio will be 70%, which is in the range that makes us comfortable with the sustainability of the dividend.
The company's dividend history has been marked by instability, with at least 1 cut in the last 10 years. The first annual payment during the last 10 years was UK£1.14 in 2012, and the most recent fiscal year payment was UK£2.18. This works out to be a compound annual growth rate (CAGR) of approximately 6.7% a year over that time. It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. British American Tobacco might have put its house in order since then, but we remain cautious.
The Dividend's Growth Prospects Are Limited
Growing earnings per share could be a mitigating factor when considering the past fluctuations in the dividend. Earnings per share has been crawling upwards at 3.5% per year. There are exceptions, but limited earnings growth and a high payout ratio can signal that a company has reached maturity. When a company prefers to pay out cash to its shareholders instead of reinvesting it, this can often say a lot about that company's dividend prospects.
In summary, it's great to see that the company can raise the dividend and keep it in a sustainable range. The payout ratio looks good, but unfortunately the company's dividend track record isn't stellar. The payment isn't stellar, but it could make a decent addition to a dividend portfolio.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. As an example, we've identified 2 warning signs for British American Tobacco that you should be aware of before investing. If you are a dividend investor, you might also want to look at our curated list of high yield dividend stocks.
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