Is Caterpillar Inc. (NYSE:CAT) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 high yield and a long history of paying dividends is an appealing combination for Caterpillar. We’d guess that plenty of investors have purchased it for the income. During the year, the company also conducted a buyback equivalent to around 5.4% of its market capitalisation. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Explore this interactive chart for our latest analysis on Caterpillar!
NYSE:CAT Historical Dividend Yield, February 28th 2020
Payout ratios
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. Caterpillar paid out 36% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. The company paid out 50% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Caterpillar has available to meet other needs. It’s positive to see that Caterpillar’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.
Is Caterpillar’s Balance Sheet Risky?
As Caterpillar has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 2.84 times its EBITDA, Caterpillar has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. With EBIT of 37.05 times its interest expense, Caterpillar’s interest cover is quite strong – more than enough to cover the interest expense.
Consider getting our latest analysis on Caterpillar’s financial position here.
Dividend Volatility
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 Caterpillar’s dividend 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$1.68 in 2010, compared to US$4.12 last year. Dividends per share have grown at approximately 9.4% per year over this 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
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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it’s great to see Caterpillar has grown its earnings per share at 22% per annum over the past five years. With high earnings per share growth in recent times and a modest payout ratio, we think this is an attractive combination if earnings can be reinvested to generate further growth.
Conclusion
To summarise, shareholders should always check that Caterpillar’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Caterpillar pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Caterpillar performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 18 analysts we track are forecasting for Caterpillar for free with public analyst estimates for the company.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
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.
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.