Dividend investors consider many things when looking to find quality stocks to invest in. One of those things is the dividend yield, and many will tell you that anything more than 5% is simply unsustainable and will be due for a cut at some point.
The problem with this logic is that the dividend yield changes based on price, and so a stock that has crashed in price didn’t all of a sudden raise its payments to an unsustainable amount; all that’s happened is that the denominator has decreased, while the numerator has (presumably) stayed constant.
This is what happened to Corus Entertainment Inc. (TSX:CJR.B) when the company released a poor quarterly result this month, which sent the stock into a big sell-off, as investors went into a panic. Apparently, the threat of online streaming from companies like Amazon.com, Inc. and Netflix, Inc. was just discovered by some investors.
The truth is, it was always a threat, and while cord cutting has resulted in companies losing subscribers, it has not resulted in the death of cable, as many thought it would. I’ve tried cutting the cord, and there are many reasons why I don’t see it as a serious threat.
However, that panic has sent the media company’s stock into sell mode. The dividend payout may be unsustainable, but it’s not because the stock dropped in price. Let’s take a closer look at the company’s financials to see whether or not the dividend is truly in trouble.
Payout ratio as a percentage of income
When assessing whether a payout is sustainable, investors should consider the company’s net income. In the trailing 12 months, Corus has achieved earnings per share of $0.97. The company pays a monthly dividend of $0.095, meaning on annual basis, its payouts per share would total $1.14, and that equates to a payout ratio of 118%.
While that is a very high ratio, and it certainly appears to be unsustainable, looking solely at net income is not an ideal way to evaluate a company’s ability to pay dividends, since it includes non-cash items like depreciation.
Payouts as a percentage of free cash
I’d consider free cash to be a more indicative measure of whether or not a company can make dividend payments, since it represents what is left after operations and capital spending and is in essence what the company has “free” to either distribute to its shareholders or add to its bank account.
In the last four quarters, Corus has had free cash of $335 million, and dividend payments of $129 million are well short of that total. The company has generated strong free cash in each of the last four quarters, and it suggests that Corus does not need to cut its dividend. That doesn’t mean that the company won’t reduce its dividend, but it’s not in a dire situation, as some people may have you believe.
The stock is trading at all-time lows, and it won’t stay this low for long. At this price, Corus could be one of the best buys on the TSX this year.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Fool contributor David Jagielski has no position in any of the stocks mentioned. David Gardner owns shares of Amazon and Netflix. Tom Gardner owns shares of Netflix. The Motley Fool owns shares of Amazon and Netflix.