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Is Illinois Tool Works Inc. (NYSE:ITW) An Attractive Dividend Stock?

Simply Wall St

Dividend paying stocks like Illinois Tool Works Inc. (NYSE:ITW) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

While Illinois Tool Works's 2.8% dividend yield is not the highest, we think its lengthy payment history is quite interesting. The company also bought back stock during the year, equivalent to approximately 3.4% of the company's market capitalisation at the time. There are a few simple ways to reduce the risks of buying Illinois Tool Works for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Illinois Tool Works!

NYSE:ITW Historical Dividend Yield, September 24th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 53% of Illinois Tool Works's profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Of the free cash flow it generated last year, Illinois Tool Works paid out 48% as dividends, suggesting the dividend is affordable. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

We update our data on Illinois Tool Works every 24 hours, so you can always get our latest analysis of its financial health, 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. Illinois Tool Works has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$1.24 in 2009, compared to US$4.28 last year. Dividends per share have grown at approximately 13% per year over this time.

It's rare to find a company that has grown its dividends rapidly over ten years and not had any notable cuts, but Illinois Tool Works has done it, which we really like.

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 Illinois Tool Works has been growing its earnings per share at 15% a year over the past five years. Earnings per share have been growing rapidly, but given that it is paying out more than half of its earnings as dividends, we wonder how Illinois Tool Works will keep funding its growth projects in the future.

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. First, we think Illinois Tool Works has an acceptable payout ratio and its dividend is well covered by cashflow. Next, growing earnings per share and steady dividend payments is a great combination. Illinois Tool Works performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 19 Illinois Tool Works 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.