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Today we'll take a closer look at Toll Brothers, Inc. (NYSE:TOL) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.
Some readers mightn't know much about Toll Brothers's 1.1% dividend, as it has only been paying distributions for the last three years. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. During the year, the company also conducted a buyback equivalent to around 4.3% of its market capitalisation. Some simple analysis can reduce the risk of holding Toll Brothers for its dividend, and we'll focus on the most important aspects below.
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Payout ratios
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. 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. Toll Brothers paid out 9.2% of its profit as dividends, over the trailing twelve month period. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Toll Brothers's cash payout ratio last year was 10%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Toll Brothers'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.
Consider getting our latest analysis on Toll Brothers's financial position here.
Dividend Volatility
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past three-year period, the first annual payment was US$0.32 in 2016, compared to US$0.44 last year. This works out to be a compound annual growth rate (CAGR) of approximately 11% a year over that time.