W.W. Grainger, Inc.'s (NYSE:GWW) Attractive Combination: Does It Earn A Place In Your Dividend Portfolio?

Dividend paying stocks like W.W. Grainger, Inc. (NYSE:GWW) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

While W.W. Grainger's 1.5% dividend yield is not the highest, we think its lengthy payment history is quite interesting. The company also bought back stock during the year, equivalent to approximately 0.7% of the company's market capitalisation at the time. There are a few simple ways to reduce the risks of buying W.W. Grainger for its dividend, and we'll go through these below.

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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. 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, W.W. Grainger paid out 50% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. W.W. Grainger's cash payout ratio in the last year was 37%, which suggests dividends were well covered by cash generated by the business. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Consider getting our latest analysis on W.W. Grainger's financial position here.

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. W.W. Grainger has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past 10-year period, the first annual payment was US$1.8 in 2010, compared to US$6.1 last year. Dividends per share have grown at approximately 13% per year over this time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

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. W.W. Grainger's EPS are effectively flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. W.W. Grainger is paying out less than half of its earnings, which we like. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?

Conclusion

To summarise, shareholders should always check that W.W. Grainger'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 W.W. Grainger has low and conservative payout ratios. Earnings per share have not been growing, but we respect a company that maintains a relatively stable dividend. All things considered, W.W. Grainger looks like a strong prospect. At the right valuation, it could be something special.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we've picked out 4 warning signs for W.W. Grainger that investors should take into consideration.

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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