Stock Analysis

Is SSE plc's (LON:SSE) 5.3% Dividend Worth Your Time?

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LSE:SSE
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Is SSE plc (LON:SSE) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

In this case, SSE likely looks attractive to investors, given its 5.3% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. There are a few simple ways to reduce the risks of buying SSE for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

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LSE:SSE Historic Dividend December 31st 2020

Payout ratios

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. SSE paid out 79% of its profit as dividends, over the trailing twelve month period. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. SSE paid out 163% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. 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. SSE paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to SSE's ability to maintain its dividend.

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

Dividend Volatility

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. SSE has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was UK£0.7 in 2010, compared to UK£0.8 last year. This works out to be a compound annual growth rate (CAGR) of approximately 1.4% a year over that time. SSE's dividend payments have fluctuated, so it hasn't grown 1.4% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. It's good to see SSE has been growing its earnings per share at 16% a year over the past five years. Earnings per share are growing nicely, but the company is paying out most of its earnings as dividends. This might be sustainable, but we wonder why SSE is not retaining those earnings to reinvest in 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. SSE gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. In sum, we find it hard to get excited about SSE from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Case in point: We've spotted 2 warning signs for SSE (of which 1 is concerning!) you should know about.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

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