Would Avery Dennison Corporation (NYSE:AVY) Be Valuable To Income Investors?

Is Avery Dennison Corporation (NYSE:AVY) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

A 1.7% yield is nothing to get excited about, but investors probably think the long payment history suggests Avery Dennison has some staying power. The company also bought back stock during the year, equivalent to approximately 2.2% of the company’s market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.

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NYSE:AVY Historical Dividend Yield, February 11th 2020
NYSE:AVY Historical Dividend Yield, February 11th 2020

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable – hardly an ideal situation. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. Avery Dennison paid out 63% of its profit as dividends, over the trailing twelve month period. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Of the free cash flow it generated last year, Avery Dennison paid out 39% as dividends, suggesting the dividend is affordable. It’s positive to see that Avery Dennison’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.

We update our data on Avery Dennison 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. For the purpose of this article, we only scrutinise the last decade of Avery Dennison’s dividend payments. The dividend has been cut on at least one occasion historically. During the past ten-year period, the first annual payment was US$1.64 in 2010, compared to US$2.32 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.5% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

We’re glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don’t think this is an attractive combination.

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. Earnings have grown at around 6.3% a year for the past five years, which is better than seeing them shrink! Earnings per share are growing at an acceptable rate, although the company is paying out more than half of its profits, which we think could constrain its ability to reinvest in its business.

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. First, we think Avery Dennison has an acceptable payout ratio and its dividend is well covered by cashflow. Second, earnings growth has been ordinary, and its history of dividend payments is chequered – having cut its dividend at least once in the past. While we’re not hugely bearish on it, overall we think there are potentially better dividend stocks than Avery Dennison out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 13 analysts we track are forecasting for Avery Dennison 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%.

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.

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. Thank you for reading.