Stock Analysis

Here's How We Evaluate Direct Line Insurance Group plc's (LON:DLG) Dividend

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LSE:DLG
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Today we'll take a closer look at Direct Line Insurance Group plc (LON:DLG) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

In this case, Direct Line Insurance Group likely looks attractive to dividend investors, given its 4.7% dividend yield and eight-year payment history. It sure looks interesting on these metrics - but there's always more to the story. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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historic-dividend
LSE:DLG Historic Dividend February 19th 2021

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. In the last year, Direct Line Insurance Group paid out 26% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

Consider getting our latest analysis on Direct Line Insurance Group's financial position here.

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 Direct Line Insurance Group, in the last decade, was eight years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past eight-year period, the first annual payment was UK£0.09 in 2013, compared to UK£0.1 last year. Dividends per share have grown at approximately 6.8% per year over this time. Direct Line Insurance Group's dividend payments have fluctuated, so it hasn't grown 6.8% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Direct Line Insurance Group might have put its house in order since then, but we remain cautious.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Direct Line Insurance Group's EPS are effectively flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation.

We'd also point out that Direct Line Insurance Group issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.

Conclusion

To summarise, shareholders should always check that Direct Line Insurance Group'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 Direct Line Insurance Group has a low and conservative payout ratio. Earnings per share are down, and Direct Line Insurance Group's dividend has been cut at least once in the past, which is disappointing. In summary, we're unenthused by Direct Line Insurance Group as a dividend stock. It's not that we think it is a bad company; it simply falls short of our criteria in some key areas.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we've picked out 1 warning sign for Direct Line Insurance Group that investors should take into consideration.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

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