Is It Worth Buying Lockheed Martin Corporation (NYSE:LMT) For Its 2.5% Dividend Yield?

Today we'll take a closer look at Lockheed Martin Corporation (NYSE:LMT) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

While Lockheed Martin's 2.5% dividend yield is not the highest, we think its lengthy payment history is quite interesting. The company also bought back stock equivalent to around 1.3% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Lockheed Martin for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Lockheed Martin!

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. Looking at the data, we can see that 42% of Lockheed Martin's profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Of the free cash flow it generated last year, Lockheed Martin paid out 37% as dividends, suggesting the dividend is affordable. It's positive to see that Lockheed Martin'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.

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 Lockheed Martin'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$2.28 in 2009, compared to US$9.60 last year. Dividends per share have grown at approximately 15% per year over this time.

It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but Lockheed Martin has done it, which we really like.

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. It's good to see Lockheed Martin has been growing its earnings per share at 18% a year over the past five years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. Next, growing earnings per share and steady dividend payments is a great combination. Lockheed Martin has met all of our criteria, including having strong cash flow that covers the dividend. We definitely think it would be worthwhile looking closer.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 18 Lockheed Martin analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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.