Some investors rely on dividends for growing their wealth, and if you're one of those dividend sleuths, you might be intrigued to know that Merck & Co., Inc. (NYSE:MRK) is about to go ex-dividend in just 4 days. Ex-dividend means that investors that purchase the stock on or after the 12th of March will not receive this dividend, which will be paid on the 7th of April.
Merck's upcoming dividend is US$0.65 a share, following on from the last 12 months, when the company distributed a total of US$2.60 per share to shareholders. Looking at the last 12 months of distributions, Merck has a trailing yield of approximately 3.6% on its current stock price of $73.13. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to investigate whether Merck can afford its dividend, and if the dividend could grow.
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. Its dividend payout ratio is 87% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth. It could become a concern if earnings started to decline. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. Over the past year it paid out 112% of its free cash flow as dividends, which is uncomfortably high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.
While Merck's dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were this to happen repeatedly, this would be a risk to Merck's ability to maintain its dividend.
Have Earnings And Dividends Been Growing?
Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. For this reason, we're glad to see Merck's earnings per share have risen 12% per annum over the last five years. Earnings have been growing at a decent rate, but we're concerned dividend payments consumed most of the company's cash flow over the past year.
The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Since the start of our data, 10 years ago, Merck has lifted its dividend by approximately 5.5% a year on average. It's good to see both earnings and the dividend have improved - although the former has been rising much quicker than the latter, possibly due to the company reinvesting more of its profits in growth.
To Sum It Up
Has Merck got what it takes to maintain its dividend payments? Earnings per share growth is a positive, and the company's payout ratio looks normal. However, we note Merck paid out a much higher percentage of its free cash flow, which makes us uncomfortable. It might be worth researching if the company is reinvesting in growth projects that could grow earnings and dividends in the future, but for now we're not all that optimistic on its dividend prospects.
If you want to look further into Merck, it's worth knowing the risks this business faces. For example, we've found 2 warning signs for Merck that we recommend you consider before investing in the business.
If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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