Is Illinois Tool Works Inc. (NYSE:ITW) A Smart Choice For Dividend Investors?

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Dividend paying stocks like Illinois Tool Works Inc. (NYSE:ITW) 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. Unfortunately, it’s common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

A slim 2.6% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Illinois Tool Works could have potential. The company also bought back stock equivalent to around 3.7% of market capitalisation this year. Before you buy any stock for its dividend however, you should always remember Warren Buffett’s two rules: 1) Don’t lose money, and 2) Remember rule #1. We’ll run through some checks below to help with this.

Explore this interactive chart for our latest analysis on Illinois Tool Works!

NYSE:ITW Historical Dividend Yield, June 21st 2019
NYSE:ITW Historical Dividend Yield, June 21st 2019

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. 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. In the last year, Illinois Tool Works paid out 50% of its profit as dividends. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Of the free cash flow it generated last year, Illinois Tool Works paid out 47% as dividends, suggesting the dividend is affordable. 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.

We update our data on Illinois Tool Works every 24 hours, so you can always get our latest analysis of its financial health, 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. For the purpose of this article, we only scrutinise the last decade of Illinois Tool Works’s dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$1.24 in 2009, compared to US$4.00 last year. Dividends per share have grown at approximately 12% per year over this time.

With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see Illinois Tool Works has grown its earnings per share at 16% per annum over the past five years. Illinois Tool Works’s earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.

Conclusion

Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Illinois Tool Works’s payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Next, growing earnings per share and steady dividend payments is a great combination. All things considered, Illinois Tool Works looks like a strong prospect. At the right valuation, it could be something special.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 19 Illinois Tool Works analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.