Stock Analysis

Key Things To Watch Out For If You Are After SSE plc's (LON:SSE) 5.4% Dividend

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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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With SSE yielding 5.4% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can reduce the risk of holding SSE for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on SSE!

historic-dividend
LSE:SSE Historic Dividend May 11th 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. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 163%, SSE's dividend payments are poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. 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. Cash is king, as they say, and were SSE to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

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

Dividend Volatility

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. For the purpose of this article, we only scrutinise the last decade of SSE's dividend payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was UK£0.7 in 2011, compared to UK£0.8 last year. Dividends per share have grown at approximately 1.4% per year over this 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.

Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

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? 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

To summarise, shareholders should always check that SSE's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think SSE has an acceptable payout ratio, although its dividend was not well covered by cashflow. We were also glad to see it growing earnings, but it was concerning to see 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. For example, we've identified 3 warning signs for SSE (2 don't sit too well with us!) that you should be aware of before investing.

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

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