Could the Southern Company (NYSE: SO) be an attractive dividend stock to hold for the long term? Investors are often drawn to strong companies with the idea of reinvesting dividends. On the other hand, it is known that investors buy a stock because of its performance and then lose money if the dividend of the company does not meet expectations.
High yield and a long history of paying dividends is an attractive combination for Southern. We’ll assume that many investors bought it for income. Simple analysis can reduce the risk of holding Southern for its dividend, and we’ll focus on the more important aspects below.
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Dividends are generally paid out of company profits. If a company pays more in dividends than it has earned, then the dividend can become unsustainable – which is hardly an ideal situation. Therefore, we should always research whether a company can afford its dividend, measured as a percentage of a company’s net profit after tax. Southern has paid out 86% of its profits in the form of dividends over the past twelve months. The payment of the majority of its income limits the amount that can be reinvested in the business. This may indicate a commitment to pay a dividend or a dearth of investment opportunities.
In addition to comparing dividends to earnings, we need to check whether the company has generated enough cash to pay its dividend. Unfortunately, while Southern is paying a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it is not ideal from a dividend standpoint.
Consider getting our latest analysis on Southern’s financial situation here.
From the perspective of an income investor who wants to earn dividends for many years, there is no point in buying a stock if its dividend is regularly reduced or unreliable. Southern has been paying dividends for a long time, but for the purposes of this analysis, we’re only looking at the past 10 years of payouts. During this period, the dividend has been stable, which could imply that the company could have relatively constant profit power. For the past 10 years, the first annual payment was $ 1.8 in 2011, up from $ 2.6 last year. Dividends per share have increased by approximately 3.5% per year during this period.
While the regularity of dividend payments is impressive, we think the relatively slow rate of growth is unattractive.
Potential for dividend growth
If dividend payments have been relatively reliable, it would also be interesting for earnings per share (EPS) to increase, as this is essential to maintain the purchasing power of the dividend over the long term. Southern has grown its earnings per share by 2.5% per year over the past five years. Profits do not increase quickly at all and the company pays most of its profits in the form of dividends. That’s fine as long as it’s going, but we’re less excited as this often indicates that the dividend will likely grow more slowly in the future.
Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a history of consistent payments, and c) if the dividend is capable of growing. Southern gets an impact on its dividend payout ratio, but it has paid out substantially all of its cash flow as dividends. It might only be once, but we’ll be keeping an eye on that. Earnings growth has been limited, but we like the fact that dividend payouts have been fairly consistent. In short, we find it hard to get excited about Southern from a dividend perspective. It’s not that we think it’s a bad deal; just that there are other companies that perform better on these criteria.
Investors generally tend to favor companies with a consistent and stable dividend policy over those with an irregular policy. Meanwhile, despite the importance of dividend payments, these aren’t the only factors our readers should be aware of when evaluating a business. To this end, Southern has 3 warning signs (and 1 which doesn’t suit us very well) we think you should know.
If you are a dividend investor, you can also check out our curated list of dividend stocks that have a yield above 3%.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
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