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Dividend paying stocks like Unilever PLC (LON:ULVR) 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.
Investors might not know much about Unilever’s dividend prospects, even though it has been paying dividends for the last nine years and offers a 2.8% yield. While the yield may not look too great, the relatively long payment history is interesting. The company also bought back stock equivalent to around 4.4% of market capitalisation this year. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.
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. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Unilever paid out 43% of its profit as dividends. 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. Unilever paid out 78% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. 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.
Consider getting our latest analysis on Unilever’s financial position here.
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. Looking at the last decade of data, we can see that Unilever paid its first dividend at least 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 €0.75 in 2010, compared to €1.52 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.2% a year over that time.
The dividend has been growing at a reasonable rate, which we like. We’re conscious though that one of the best ways to detect a multi-decade consistent dividend payer, is to watch a company pay dividends for 20 years – a distinction Unilever has not achieved yet.
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. It’s good to see Unilever has been growing its earnings per share at 15% a year over the past 5 years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.
To summarise, shareholders should always check that Unilever’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Unilever pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we’d like. Overall we think Unilever is an interesting dividend stock, although it could be better.
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 Unilever for free with public analyst estimates for the company.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.