Today we'll take a closer look at Associated British Foods plc (LON:ABF) 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. 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 1.8% yield is nothing to get excited about, but investors probably think the long payment history suggests Associated British Foods has some staying power. Some simple analysis can reduce the risk of holding Associated British Foods for its dividend, and we'll focus on the most important aspects below.
Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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, Associated British Foods paid out 42% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Of the free cash flow it generated last year, Associated British Foods paid out 46% as dividends, suggesting the dividend is affordable. 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.
With a strong net cash balance, Associated British Foods investors may not have much to worry about in the near term from a dividend perspective.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Associated British Foods's 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 ten-year period, the first annual payment was UK£0.20 in 2010, compared to UK£0.46 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.6% a year over that time.
Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.
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. Associated British Foods has grown its earnings per share at 2.9% per annum over the past five years. Associated British Foods is paying out less than half of its earnings, which we like. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?
To summarise, shareholders should always check that Associated British Foods's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Associated British Foods is paying out a low percentage of its earnings and cash flow. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. Overall we think Associated British Foods 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 19 analysts we track are forecasting for Associated British Foods 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 email@example.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.