Should You Buy ABB Ltd (VTX:ABBN) For Its Dividend?
Simply Wall St
Could ABB Ltd (VTX:ABBN) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
With ABB yielding 4.2% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
SWX:ABBN Historical Dividend Yield, September 4th 2019
Payout ratios
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 196% of ABB's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. With a cash payout ratio of 122%, ABB's dividend payments are poorly covered by cash flow. Cash is slightly more important than profit from a dividend perspective, but given ABB's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.
Is ABB's Balance Sheet Risky?
As ABB's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) 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). ABB has net debt of 2.21 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 18.48 times its interest expense, ABB's interest cover is quite strong - more than enough to cover the interest expense.
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. ABB 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 ten-year period, the first annual payment was US$0.45 in 2009, compared to US$0.78 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.7% a year over that time.
Businesses that can grow their dividends at a decent rate and maintain a stable payout can generate substantial wealth for shareholders over the long term.
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. ABB's earnings per share have shrunk at 20% a year over the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.
Conclusion
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. We're a bit uncomfortable with ABB paying out a high percentage of both its cashflow and earnings. Earnings per share have not been growing, but we respect a company that maintains a relatively stable dividend. In this analysis, ABB doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.
Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 23 analysts we track are forecasting for the future.
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.
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. Thank you for reading.
