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Dividend paying stocks like Northrop Grumman Corporation (NYSE:NOC) 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 1.6% yield is nothing to get excited about, but investors probably think the long payment history suggests Northrop Grumman has some staying power. The company also bought back stock equivalent to around 2.7% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.Explore this interactive chart for our latest analysis on Northrop Grumman!
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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 25% of Northrop Grumman’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.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Northrop Grumman’s cash payout ratio in the last year was 43%, which suggests dividends were well covered by cash generated by the business.
Is Northrop Grumman’s Balance Sheet Risky?
As Northrop Grumman has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick way to check a company’s financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures a company’s total debt load relative to its earnings (lower = less debt), while net interest cover measures the company’s ability to pay the interest on its debt (higher = greater ability to pay interest costs). Northrop Grumman is carrying net debt of 3.05 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Net interest cover of 7.61 times its interest expense appears reasonable for Northrop Grumman, although we’re conscious that even high interest cover doesn’t make a company bulletproof.
Remember, you can always get a snapshot of Northrop Grumman’s latest financial position, by checking our visualisation of its financial health.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of Northrop Grumman’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$1.72 in 2009, compared to US$4.80 last year. Dividends per share have grown at approximately 11% per year over this time.
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 Northrop Grumman has grown its earnings per share at 17% per annum over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.
To summarise, shareholders should always check that Northrop Grumman’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It’s great to see that Northrop Grumman is paying out a low percentage of its earnings and cash flow. Next, growing earnings per share and steady dividend payments is a great combination. Northrop Grumman 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 16 Northrop Grumman 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 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.