Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Illinois Tool Works Inc. (NYSE:ITW) is about to trade ex-dividend in the next four days. Ex-dividend means that investors that purchase the stock on or after the 30th of March will not receive this dividend, which will be paid on the 14th of April.
Illinois Tool Works's next dividend payment will be US$1.14 per share, and in the last 12 months, the company paid a total of US$4.56 per share. Based on the last year's worth of payments, Illinois Tool Works stock has a trailing yield of around 2.1% on the current share price of $220.36. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.
Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Illinois Tool Works paid out 66% of its earnings to investors last year, a normal payout level for most businesses. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. Dividends consumed 54% of the company's free cash flow last year, which is within a normal range for most dividend-paying organisations.
It's positive to see that Illinois Tool Works'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.
Have Earnings And Dividends Been Growing?
Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. If earnings fall far enough, the company could be forced to cut its dividend. This is why it's a relief to see Illinois Tool Works earnings per share are up 5.2% per annum over the last five years. Decent historical earnings per share growth suggests Illinois Tool Works has been effectively growing value for shareholders. However, it's now paying out more than half its earnings as dividends. Therefore it's unlikely that the company will be able to reinvest heavily in its business, which could presage slower growth in the future.
The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the past 10 years, Illinois Tool Works has increased its dividend at approximately 14% a year on average. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.
The Bottom Line
Has Illinois Tool Works got what it takes to maintain its dividend payments? Earnings per share have been growing modestly and Illinois Tool Works paid out a bit over half of its earnings and free cash flow last year. While it does have some good things going for it, we're a bit ambivalent and it would take more to convince us of Illinois Tool Works's dividend merits.
If you're not too concerned about Illinois Tool Works's ability to pay dividends, you should still be mindful of some of the other risks that this business faces. For example, we've found 1 warning sign for Illinois Tool Works that we recommend you consider before investing in the business.
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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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