Is Graham Holdings Company (NYSE:GHC) A Smart Choice For Dividend Investors?

Today we'll take a closer look at Graham Holdings Company (NYSE:GHC) 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 your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

A 1.0% yield is nothing to get excited about, but investors probably think the long payment history suggests Graham Holdings has some staying power. The company also returned around 4.0% of its market capitalisation to shareholders in the form of stock buybacks over the past year. That said, the recent jump in the share price will make Graham Holdings's dividend yield look smaller, even though the company prospects could be improving. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Graham Holdings paid out 14% of its profit as dividends. We'd say its dividends are thoroughly covered by earnings.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Graham Holdings' cash payout ratio last year was 12%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's positive to see that Graham Holdings' 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.

While the above analysis focuses on dividends relative to a company's earnings, we do note Graham Holdings' strong net cash position, which will let it pay larger dividends for a time, should it choose.

Consider getting our latest analysis on Graham Holdings' financial position 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. Graham Holdings 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 cut on at least one occasion historically. During the past 10-year period, the first annual payment was US$9.0 in 2011, compared to US$6.0 last year. This works out to be a decline of approximately 3.9% per year over that time. Graham Holdings' dividend hasn't shrunk linearly at 3.9% per annum, but the CAGR is a useful estimate of the historical rate of change.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Graham Holdings has grown its earnings per share at 17% per annum over the past five years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.

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. Firstly, we like that Graham Holdings has low and conservative payout ratios. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. All things considered, Graham Holdings looks like a strong prospect. At the right valuation, it could be something special.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. However, there are other things to consider for investors when analysing stock performance. For example, we've picked out 1 warning sign for Graham Holdings that investors should know about before committing capital to this stock.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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