Dividend paying stocks like Canadian Pacific Railway Limited (TSE:CP) 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 the income from dividends, it’s important to be a lot more stringent with your investments than the average punter.
A 1.1% yield is nothing to get excited about, but investors probably think the long payment history suggests Canadian Pacific Railway has some staying power. The company also returned around 3.3% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple analysis can reduce the risk of holding Canadian Pacific Railway for its dividend, and we’ll focus on the most important aspects below.
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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. 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 19% of Canadian Pacific Railway’s profits were paid out as dividends in the last 12 months. We’d say its dividends are thoroughly covered by earnings.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Canadian Pacific Railway paid out a conservative 34% of its free cash flow as dividends last year. It’s positive to see that Canadian Pacific Railway’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 Canadian Pacific Railway’s Balance Sheet Risky?
As Canadian Pacific Railway 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. Canadian Pacific Railway has net debt of 2.08 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Net interest cover of 8.47 times its interest expense appears reasonable for Canadian Pacific Railway, although we’re conscious that even high interest cover doesn’t make a company bulletproof.
Remember, you can always get a snapshot of Canadian Pacific Railway’s latest financial position, by checking our visualisation of its financial health.
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. For the purpose of this article, we only scrutinise the last decade of Canadian Pacific Railway’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 CA$0.99 in 2010, compared to CA$3.32 last year. This works out to be a compound annual growth rate (CAGR) of approximately 13% a year over that time.
With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.
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 Canadian Pacific Railway has grown its earnings per share at 15% per annum over the past five years. Earnings per share are growing at a solid clip, and the payout ratio is low. We think this is an ideal combination in a dividend stock.
To summarise, shareholders should always check that Canadian Pacific Railway’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 Canadian Pacific Railway has low and conservative payout ratios. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. All these things considered, we think this organisation has a lot going for it from a dividend perspective.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. However, there are other things to consider for investors when analysing stock performance. For example, we’ve picked out 1 warning sign for Canadian Pacific Railway that investors should know about before committing capital to this stock.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.
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.