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What To Know Before Buying Direct Line Insurance Group plc (LON:DLG) For Its Dividend

Simply Wall St

Is Direct Line Insurance Group plc (LON:DLG) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Direct Line Insurance Group is a new dividend aristocrat in the making. It sure looks interesting on these metrics - but there's always more to the story . When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Direct Line Insurance Group!

LSE:DLG Historical Dividend Yield, December 6th 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. 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. Looking at the data, we can see that 67% of Direct Line Insurance Group's profits were paid out as dividends in the last 12 months. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

Remember, you can always get a snapshot of Direct Line Insurance Group's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the data, we can see that Direct Line Insurance Group has been paying a dividend for the past seven years. It's good to see that Direct Line Insurance Group has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past seven-year period, the first annual payment was UK£0.087 in 2012, compared to UK£0.29 last year. This works out to be a compound annual growth rate (CAGR) of approximately 19% a year over that time. Direct Line Insurance Group's dividend payments have fluctuated, so it hasn't grown 19% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Earnings have grown at around 6.8% a year for the past five years, which is better than seeing them shrink! Earnings per share are growing at an acceptable rate, although the company is paying out more than half of its profits, which we think could constrain its ability to reinvest in its business.

Conclusion

To summarise, shareholders should always check that Direct Line Insurance Group's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Direct Line Insurance Group's payout ratio is within normal bounds. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Direct Line Insurance Group out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 12 analysts we track are forecasting for Direct Line Insurance Group for free with public analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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.

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. Thank you for reading.