Dividend paying stocks like Meggitt PLC (LON:MGGT) 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. 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 2.7% yield is nothing to get excited about, but investors probably think the long payment history suggests Meggitt has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 90% of Meggitt's profits were paid out as dividends in the last 12 months. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable - still, we think it is a concern.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Meggitt paid out 79% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. It's good to see that while Meggitt's dividends were not well covered by profits, at least they are affordable from a free cash flow perspective. Even so, if the company were to continue paying out almost all of its profits, we'd be concerned about whether the dividend is sustainable in a downturn.
Is Meggitt's Balance Sheet Risky?
As Meggitt's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 2.87 times its EBITDA, Meggitt has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Meggitt has EBIT of 7.08 times its interest expense, which we think is adequate.
Consider getting our latest analysis on Meggitt's financial position here.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of Meggitt'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£0.085 in 2009, compared to UK£0.17 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.0% 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
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. It's not great to see that Meggitt's have fallen at approximately 8.6% over the past five years. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.
To summarise, shareholders should always check that Meggitt's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're not keen on the fact that Meggitt paid out such a high percentage of its income, although its cashflow is in better shape. It's not great to see earnings per share shrinking. The dividends have been relatively consistent, but we wonder for how much longer this will be true. In summary, Meggitt has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 14 analysts are forecasting a turnaround in our free collection of analyst estimates here.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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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. Thank you for reading.