Dividend paying stocks like Packaging Corporation of America (NYSE:PKG) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A slim 3.0% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Packaging Corporation of America could have potential. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Packaging Corporation of America paid out 69% of its profit as dividends, over the trailing twelve month period. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Packaging Corporation of America paid out 49% as dividends, suggesting the dividend is affordable. It's positive to see that Packaging Corporation of America'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. Packaging Corporation of America has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past 10-year period, the first annual payment was US$0.6 in 2011, compared to US$4.0 last year. This works out to be a compound annual growth rate (CAGR) of approximately 21% a year over that time.
It's rare to find a company that has grown its dividends rapidly over 10 years and not had any notable cuts, but Packaging Corporation of America has done it, which we really like.
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. Packaging Corporation of America's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. 1.7% per annum is not a particularly high rate of growth, which we find curious. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Packaging Corporation of America's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Second, earnings growth is pretty limited, but at least the dividends have been relatively stable. Overall we think Packaging Corporation of America is an interesting dividend stock, although it could be better.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. For instance, we've picked out 3 warning signs for Packaging Corporation of America that investors should take into consideration.
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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