Is CDK Global, Inc. ( NASDAQ:CDK ) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
Investors might not know much about CDK Global's dividend prospects, even though it has been paying dividends for the last five years and offers a 1.3% yield. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. The company also bought back stock during the year, equivalent to approximately 11% of the company's market capitalisation at the time. Some simple analysis can reduce the risk of holding CDK Global for its dividend, and we'll focus on the most important aspects below.
Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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 20% of CDK Global's profits were paid out as dividends in the last 12 months. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. CDK Global paid out 21% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's positive to see that CDK Global'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 CDK Global's Balance Sheet Risky?
As CDK Global has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) 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. CDK Global has net debt of 3.48 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.
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 5.68 times its interest expense appears reasonable for CDK Global, although we're conscious that even high interest cover doesn't make a company bulletproof.
We update our data on CDK Global every 24 hours, so you can always get our latest analysis of its financial health, here.
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. Looking at the data, we can see that CDK Global has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$0.48 in 2014, compared to US$0.60 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.6% a year over that time.
It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. It's good to see CDK Global has been growing its earnings per share at 19% a year over the past 5 years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. Second, the company has not been able to generate earnings growth, and its history of dividend payments too short for us to thoroughly evaluate the dividend's consistency across an economic cycle. All things considered, CDK Global looks like a strong prospect. At the right valuation, it could be something special.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 5 CDK Global analysts we track are forecasting continued growth with our free report on analyst estimates for the company .
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org . 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. Thank you for reading.