Consider the recent article (copied below) Why Loblaw Companies Limited (TSE:L) Is A Dividend Rockstar from the financial news: a) What type of investor is Loblaw trying to attract with a long payment history? b) What does a company hope to achieve with a buyback equivalent to around 3.7% of its market capitalization? c) What might Loblaw consider when setting its earnings payout policy (payout ratio)? d) How is Loblaw risk exposure due to debt measured? e) What method (and why) from Chapter 8 is best to use for Loblaw Stock valuation?

Today we'll take a closer look at Loblaw Companies Limited (TSE:L) 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 the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A 1.8% yield is nothing to get excited about, but investors probably think the long payment history suggests Loblaw Companies has some staying power. During the year, the company also conducted a buyback equivalent to around 3.7% of its market capitalisation. There are a few simple ways to reduce the risks of buying Loblaw Companies for its dividend, and we'll go through these below.

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. Loblaw Companies paid out 42% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Loblaw Companies's cash payout ratio last year was 17%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's positive to see that Loblaw Companies'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 Loblaw Companies's Balance Sheet Risky?

As Loblaw Companies has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). Loblaw Companies has net debt of 1.87 times its EBITDA, which we think is not too troublesome.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 3.17 times its interest expense, Loblaw Companies's interest cover is starting to look a bit thin.

Consider getting our latest analysis on Loblaw Companies'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. Loblaw Companies 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 CA$0.84 in 2010, compared to CA$1.26 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.1% a year over that time.

Slow and steady dividend growth might not sound that exciting, but dividends have been stable for ten years, which we think is seriously impressive.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. It's good to see Loblaw Companies has been growing its earnings per share at 84% a year over the past five 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

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. It's great to see that Loblaw Companies is paying out a low percentage of its earnings and cash flow. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. All these things considered, we think this organisation has a lot going for it from a dividend perspective.