For not just years but decades, Medtronic (MDT 0.04%) has proven to be a reliable dividend growth stock to own. The medical device maker has been increasing its payout regularly, and with a yield of more than 3%, it pays more than twice what the S&P 500 averages (1.3%).
But these days, the stock's payout ratio is high, and investors may think twice about how safe the dividend is. A long streak, after all, is no guarantee that future payouts will be secure. Let's take a closer look at whether Medtronic's dividend is safe and if you can comfortably rely on its payout for the foreseeable future.
Medtronic's payout ratio is well over 80%
A stock's payout ratio is a key metric that dividend investors will focus on when assessing if the payout is sustainable. The higher the payout ratio is, the less room the company has to cover the dividend should its earnings deteriorate. That doesn't automatically mean that if it gets to over 100%, a dividend cut is coming. But it can be a warning sign, nonetheless.
Over the trailing 12 months, Medtronic's diluted earnings per share has totaled $3.27. And when you consider the company's annual dividend totals $2.80, that means the healthcare company is paying out approximately 86% of its earnings as dividends.
While Medtronic has regularly posted profits, the danger is that it may not be strong enough to leave room for the company to invest in its operations and continue growing its dividend, as Medtronic has been doing for years. The company has increased its dividend for an impressive 47 consecutive years, but it is clear from the chart below that the rate of those increases has indeed been slowing down.
MDT Dividend data by YCharts
What does Medtronic's free cash flow say?
Another way investors can evaluate the safety of a dividend is by reviewing a company's free cash flow. This can sometimes be a better indicator of how much room there is to support the dividend simply because free cash flow tells investors how much cash the company is generating after factoring in capital expenditures. Thus, it represents the cash that is available to either pay out as dividends or invest back into the business.
Over the past four quarters, Medtronic's free cash flow has totaled $5.5 billion. By comparison, the company has paid out $3.6 billion in dividends during that stretch. But in the past two quarters, Medtronic's free cash has been lower than its dividend payments. Cash flow can fluctuate and depend on the timing of receivables and the payment of payables, but the recent trend of not having sufficient free cash to cover dividend payments is a concern that investors should keep a watch for in future periods.
Should you invest in Medtronic for its dividend?
Medtronic's dividend appears to be safe for now. However, between its elevated payout ratio and free cash flow not being higher than its dividend in recent quarters, there are definitely signs here that the rate of dividend increases may continue to tighten up in future years. Another issue is that the dividend could hinder Medtronic's ability to aggressively grow its business, and that could be a problem for long-term investors.
In the past five years, Medtronic's stock has fallen by around 30%. While that dividend income may be appealing, investors may be questioning what it's all for if the business isn't generating a high level of growth (currently, its growth rate is around 5%) and producing strong returns. That could, however, change as investors start to potentially pay more toward value stocks -- Medtronic is trading at just 14 times next year's estimated earnings.
Overall, Medtronic's dividend is safe for now, but there may be better income-generating investments out there to choose from that can offer a better mix of growth and dividends.
