Is MSC Industrial Direct Co., Inc. (NYSE:MSM) A Smart Choice For Dividend Investors?

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Today we’ll take a closer look at MSC Industrial Direct Co., Inc. (NYSE:MSM) 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. 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 high yield and a long history of paying dividends is an appealing combination for MSC Industrial Direct. We’d guess that plenty of investors have purchased it for the income. The company also bought back stock during the year, equivalent to approximately 2.9% of the company’s market capitalisation at the time. Some simple research can reduce the risk of buying MSC Industrial Direct for its dividend – read on to learn more.

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NYSE:MSM Historical Dividend Yield, June 24th 2019
NYSE:MSM Historical Dividend Yield, June 24th 2019

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable – hardly an ideal situation. 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, MSC Industrial Direct paid out 46% of its profit as dividends. This is 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.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. MSC Industrial Direct paid out 50% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It’s positive to see that MSC Industrial Direct’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 MSC Industrial Direct’s latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well – nasty. For the purpose of this article, we only scrutinise the last decade of MSC Industrial Direct’s dividend 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 ten-year period, the first annual payment was US$0.80 in 2009, compared to US$2.52 last year. Dividends per share have grown at approximately 12% 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 MSC Industrial Direct 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. MSC Industrial Direct has grown its earnings per share at 7.0% per annum over the past five years. It’s good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term – assuming earnings can be maintained, of course.

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. MSC Industrial Direct’s dividend payout ratios are within normal bounds, although we note its cash flow is not as strong as the income statement would suggest. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. MSC Industrial Direct has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 16 MSC Industrial Direct analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.