Shareholders Are Loving Toll Brothers, Inc.'s (NYSE:TOL) 1.1% Yield

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Is Toll Brothers, Inc. (NYSE:TOL) a good dividend stock? How would you know? A dividend paying company with growing earnings can be rewarding in the long term. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

Some readers mightn't know much about Toll Brothers's 1.1% dividend, as it has only been paying distributions for the last two years. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. The company also bought back stock during the year, equivalent to approximately 5.8% of the company's market capitalisation at the time. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Payout ratios

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. In the last year, Toll Brothers paid out 9.0% of its profit as dividends. We'd say its dividends are thoroughly covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Toll Brothers's cash payout ratio last year was 8.8%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout.

We update our data on Toll Brothers every 24 hours, so you can always get our latest analysis of its financial health, here.

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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was US$0.32 in 2017, compared to US$0.44 last year. Dividends per share have grown at approximately 17% per year over this time.

Toll Brothers has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Toll Brothers has grown its earnings per share at 37% per annum over the past five years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.

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. It's great to see that Toll Brothers is paying out a low percentage of its earnings and cash flow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Overall we think Toll Brothers scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 16 analysts we track are forecasting for Toll Brothers for free with public 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.