Is Direct Line Insurance Group plc (LON:DLG) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Direct Line Insurance Group is a new dividend aristocrat in the making. It sure looks interesting on these metrics - but there's always more to the story. Some simple research can reduce the risk of buying Direct Line Insurance Group for its dividend - read on to learn more.
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. Direct Line Insurance Group paid out 26% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Plus, there is room to increase the payout ratio over time.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. The first recorded dividend for Direct Line Insurance Group, in the last decade, was eight years ago. It's good to see that Direct Line Insurance Group has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past eight-year period, the first annual payment was UK£0.09 in 2012, 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
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? 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. A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.
We'd also point out that Direct Line Insurance Group issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.
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. We're glad to see Direct Line Insurance Group has a low payout ratio, as this suggests earnings are being reinvested in the business. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. 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.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've picked out 2 warning signs for Direct Line Insurance Group that investors should know about before committing capital to this stock.
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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