High-yielding dividend stocks can be attractive options for investors. Their payouts can generate a lot of recurring income and boost overall returns from owning the stock.
But anytime a yield is around 5%, it's worth asking whether it's safe, because the last thing you want is to buy a stock for its dividend, only for the payout to be cut in the near future.
Kraft Heinz(NASDAQ: KHC) pays a high dividend that yields about 4.8% today. And it wasn't all that long ago that the popular food company cut its payout in order to bring it down to a more manageable level.
With the company recently reporting earnings numbers that are not overly impressive, is it possible that another dividend cut may be ahead, or is this a safer dividend stock than it looks?
Are Kraft's profits strong enough to sustain its current dividend rate?
In the trailing 12 months, Kraft has generated $26.1 billion in sales, but its profit margin on that was fairly light with net income totaling just $1.4 billion. Most recently, the company incurred a net loss of $290 million for the period ending Sept. 28, which was largely due to impairment losses related to goodwill and intangible assets -- they totaled more than $1.4 billion.
The company's diluted earnings per share over the past four quarters are $1.11, less than the $1.60 it pays out in dividends per share over the course of a full year. That puts its payout ratio at more than 144%.
Based on such a high payout ratio, you might assume that the dividend is not sustainable, and that another cut may be possible (the company reduced its dividend in 2019).
But this is a good example of one of the key limitations of the payout ratio, which is that one bad quarter can have a significant impact on the multiple because any negative effect on earnings can make the dividend look unsustainable. While the company posted a loss last quarter from noncash impairment write-downs, that may not accurately reflect its ability to continue paying the current dividend.
Another way for investors to assess the safety of Kraft's dividend
Rather than relying on earnings, investors can use free cash flow (FCF) to help determine if the company's dividend is manageable. Since this involves looking at cash flow alone, it will exclude the effect of noncash charges such as impairment.
Last quarter, FCF totaled $849 million, and in the past 12 months the company has generated more than $3 billion. Over a full year, Kraft pays less than $2 billion on cash dividends, which suggests that the dividend is indeed safe based on its FCF.
Kraft announced its $0.40 quarterly dividend payment on Oct. 30, the same day the company released its latest earnings results, so it doesn't appear to be concerned -- at least not yet --about its ability to keep the current dividend going.
Is Kraft a safe dividend stock to own?
The company's dividend is safer than it looks since the business is generating sufficient FCF to continue making regular payments. And there may even be room to justify an increase in the future -- but by no means is that a guarantee. Overall, if you're looking for a good dividend stock, Kraft Heinz can be a great option to add to your portfolio.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Kraft Heinz. The Motley Fool has a disclosure policy.
