Could Caterpillar Inc. (NYSE:CAT) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. 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.
A slim 1.9% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Caterpillar could have potential. The company also bought back stock equivalent to around 0.8% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Caterpillar for its dividend, and we'll go through these below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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, Caterpillar paid out 75% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. The company paid out 53% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Caterpillar has available to meet other needs. It's positive to see that Caterpillar's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Remember, you can always get a snapshot of Caterpillar's latest financial position, by checking our visualisation of its financial health.
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. Caterpillar has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past 10-year period, the first annual payment was US$1.7 in 2011, compared to US$4.1 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.4% a year over that time.
Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Caterpillar has grown its earnings per share at 5.4% per annum over the past five years. Earnings per share are growing at an acceptable rate, although the company is paying out more than half of its profits, which we think could constrain its ability to reinvest in its business.
To summarise, shareholders should always check that Caterpillar'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 Caterpillar is paying out an acceptable percentage of its cashflow and profit. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. Ultimately, Caterpillar comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Just as an example, we've come accross 2 warning signs for Caterpillar you should be aware of, and 1 of them is concerning.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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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