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Is MSC Industrial Direct Co., Inc. (NYSE:MSM) a good dividend stock? How would you know? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 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.
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. Looking at the data, we can see that 46% of MSC Industrial Direct’s profits were paid out as dividends in the last 12 months. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. 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. MSC Industrial Direct paid out 50% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. 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.
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. MSC Industrial Direct 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 ten-year period, the first annual payment was US$0.80 in 2009, compared to US$2.52 last year. This works out to be a compound annual growth rate (CAGR) of approximately 12% a year over that time.
Dividends have been growing pretty quickly, and even more impressively, they haven’t experienced any notable falls during this period.
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. Earnings have grown at around 7.0% a year for the past five years, which is better than seeing them shrink! 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.
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. 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. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. Overall we think MSC Industrial Direct is an interesting dividend stock, although it could be better.
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.
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 firstname.lastname@example.org. 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.