Today we'll take a closer look at Analog Devices, Inc. (NASDAQ:ADI) 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 slim 1.6% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Analog Devices could have potential. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
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. In the last year, Analog Devices paid out 75% of its profit as dividends. 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.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Analog Devices paid out a conservative 48% of its free cash flow as dividends last year. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.
Remember, you can always get a snapshot of Analog Devices' latest financial position, by checking our visualisation of its financial health.
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 Analog Devices' 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 10-year period, the first annual payment was US$0.8 in 2011, compared to US$2.5 last year. Dividends per share have grown at approximately 12% per year over this time.
It's rare to find a company that has grown its dividends rapidly over 10 years and not had any notable cuts, but Analog Devices has done it, which we really like.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Analog Devices has grown its earnings per share at 8.2% per annum over the past five years. The rate at which earnings have grown is quite decent, and by paying out more than half of its earnings as dividends, the company is striking a reasonable balance between reinvestment and returns to shareholders.
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 Analog Devices has an acceptable payout ratio and its dividend is well covered by cashflow. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. All things considered, Analog Devices 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. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Taking the debate a bit further, we've identified 3 warning signs for Analog Devices that investors need to be conscious of moving forward.
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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