Is Penske Automotive Group, Inc. (NYSE:PAG) 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 popular dividend stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Penske Automotive Group is a new dividend aristocrat in the making. It sure looks interesting on these metrics – but there’s always more to the story . During the year, the company also conducted a buyback equivalent to around 4.9% of its market capitalisation. Some simple analysis can reduce the risk of holding Penske Automotive Group for its dividend, and we’ll focus on the most important aspects below.
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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, Penske Automotive Group paid out 31% 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. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Penske Automotive Group paid out a conservative 48% of its free cash flow as dividends last year. It’s positive to see that Penske Automotive Group’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 Penske Automotive Group’s Balance Sheet Risky?
As Penske Automotive Group 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 is a measure of a company’s total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Penske Automotive Group has net debt of 8.32 times its EBITDA, which implies meaningful risk if interest rates rise of earnings decline.
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 3.13 times its interest expense, Penske Automotive Group’s interest cover is starting to look a bit thin. Low interest cover and high debt can create problems right when the investor least needs them, and we’re reluctant to rely on the dividend of companies with these traits.
Consider getting our latest analysis on Penske Automotive Group’s financial position here.
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. The first recorded dividend for Penske Automotive Group, in the last decade, was nine years ago. The dividend has been quite stable over the past nine years, which is great to see – although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past nine-year period, the first annual payment was US$0.28 in 2011, compared to US$1.68 last year. Dividends per share have grown at approximately 22% per year over this time.
We’re not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.
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. Earnings have grown at around 9.6% a year for the past five years, which is better than seeing them shrink! Earnings per share have been growing at a credible rate. What’s more, the payout ratio is reasonable and provides some protection to the dividend, or even the potential to increase it.
To summarise, shareholders should always check that Penske Automotive Group’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 Penske Automotive Group has low and conservative payout ratios. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we’d like. Overall we think Penske Automotive Group scores well on our analysis. It’s not quite perfect, but we’d definitely be keen to take a closer look.
It’s important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Just as an example, we’ve come accross 3 warning signs for Penske Automotive Group you should be aware of, and 1 of them is concerning.
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 [email protected] 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.
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