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The Home Depot, Inc.'s (NYSE:HD) 2.5% Dividend Yield Looks Pretty Interesting

Simply Wall St

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Could The Home Depot, Inc. ( NYSE:HD ) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

A 2.5% yield is nothing to get excited about, but investors probably think the long payment history suggests Home Depot has some staying power. The company also bought back stock during the year, equivalent to approximately 4.1% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying Home Depot for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

NYSE:HD Historical Dividend Yield, July 16th 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, Home Depot paid out 48% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Home Depot paid out 45% as dividends, suggesting the dividend is affordable. It's positive to see that Home Depot'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.

We update our data on Home Depot every 24 hours, so you can always get our latest analysis of its financial health, here.

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. Home Depot has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 US$0.90 in 2009, compared to US$5.44 last year. This works out to be a compound annual growth rate (CAGR) of approximately 20% a year over that time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

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. It's good to see Home Depot has been growing its earnings per share at 21% a year over the past 5 years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. Home Depot has met all of our criteria, including having strong cash flow that covers the dividend. We definitely think it would be worthwhile looking closer.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 29 Home Depot 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.