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Could BAE Systems plc (LON:BA.) Have The Makings Of Another Dividend Aristocrat?

Simply Wall St

Is BAE Systems plc ( LON:BA. ) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

In this case, BAE Systems likely looks attractive to investors, given its 4.1% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

LSE:BA. Historical Dividend Yield, August 6th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 54% of BAE Systems's profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. The company paid out 83% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It's positive to see that BAE Systems'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.

Remember, you can always get a snapshot of BAE Systems's latest financial position, by checking our visualisation of its financial health .

Dividend Volatility

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. For the purpose of this article, we only scrutinise the last decade of BAE Systems's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was UK£0.14 in 2009, compared to UK£0.22 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.4% a year over that time.

Dividends have grown relatively slowly, which is not great, but some investors may value the relative consistency of the dividend.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see BAE Systems has grown its earnings per share at 52% per annum over the past five years. Earnings per share are sharply up, but we wonder if paying out more than half its earnings (leaving less for reinvestment) is an implicit signal that BAE Systems's growth will be slower in the future.

Conclusion

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 think BAE Systems is paying out an acceptable percentage of its cashflow and profit. It hasn't demonstrated a strong ability to grow earnings per share, but we like that the dividend payments have been fairly consistent. Overall we think BAE Systems is an interesting dividend stock, although it could be better.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 13 BAE Systems analysts we track are forecasting continued growth with our free report on analyst estimates for the company .

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com . 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.