Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see British American Tobacco p.l.c. (LON:BATS) is about to trade ex-dividend in the next 3 days. If you purchase the stock on or after the 24th of December, you won't be eligible to receive this dividend, when it is paid on the 6th of February.
British American Tobacco's next dividend payment will be UK£0.51 per share, on the back of last year when the company paid a total of UK£2.03 to shareholders. Based on the last year's worth of payments, British American Tobacco stock has a trailing yield of around 6.2% on the current share price of £32.555. If you buy this business for its dividend, you should have an idea of whether British American Tobacco's dividend is reliable and sustainable. So we need to check whether the dividend payments are covered, and if earnings are growing.
Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. British American Tobacco is paying out an acceptable 74% of its profit, a common payout level among most companies. A useful secondary check can be to evaluate whether British American Tobacco generated enough free cash flow to afford its dividend. It distributed 45% of its free cash flow as dividends, a comfortable payout level for most companies.
It's positive to see that British American Tobacco'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.
Have Earnings And Dividends Been Growing?
Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're encouraged by the steady growth at British American Tobacco, with earnings per share up 5.6% on average over the last five years. While earnings have been growing at a credible rate, the company is paying out a majority of its earnings to shareholders. If management lifts the payout ratio further, we'd take this as a tacit signal that the company's growth prospects are slowing.
Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. British American Tobacco has delivered 9.3% dividend growth per year on average over the past ten years. We're glad to see dividends rising alongside earnings over a number of years, which may be a sign the company intends to share the growth with shareholders.
To Sum It Up
From a dividend perspective, should investors buy or avoid British American Tobacco? While earnings per share growth has been modest, British American Tobacco's dividend payouts are around an average level; without a sharp change in earnings we feel that the dividend is likely somewhat sustainable. Pleasingly the company paid out a conservatively low percentage of its free cash flow. In summary, it's hard to get excited about British American Tobacco from a dividend perspective.