Shares of CVS Health (CVS -3.44%) have been under pressure this month after the healthcare giant reported uninspiring quarterly results. It also reduced its guidance for the year. With the company facing higher costs and headwinds due to macroeconomic conditions, investors have grown wary of the stock, and its dividend as well. Now yielding around 4.8% per year, is CVS Health's dividend too high and due for a cut?
Can CVS Health afford to keep paying its dividend?
To know whether a company can maintain its current dividend, a useful metric for investors to monitor is the payout ratio. It looks at annual dividends per share versus annual earnings per share (EPS) to determine what percentage of earnings are being paid out in the form of dividends. While there have been fluctuations in the past, CVS has averaged a payout ratio of just over 50% in the past three years.
CVS Payout Ratio data by YCharts
This year, CVS management expects an annual EPS of at least $5.64. Previously, its forecast called for EPS to be $7.06 or higher. That's a significant 20% cut to the guidance. This comes as the company's health insurance business is facing higher costs due to greater utilization rates, resulting in a higher-than-expected medical benefit ratio. But given CVS' healthy buffer in the payout ratio, it still leaves the company with a manageable dividend. Annually, CVS pays $2.66 per share in dividends, which is 47% of its forecasted EPS this year. And that's the lowest point CVS expects its EPS to be; it could come in higher than that.
Given its strong financials, there's not much reason to worry about CVS paying its dividend right now.
Is CVS Health's dividend safe for the long term?
Dividend investors are normally looking for an income stock they can buy and hold and just forget about in the long run, not only in the short term. While CVS Health's dividend looks safe for the time being, there are still viable questions about its future. For example, the company has been pursuing acquisitions to bolster its operations. Last year, it acquired home health company Signify Health for $8 billion.
By scaling back on its dividend, CVS could have more room to take on additional acquisitions. This would also give it more of a buffer should medical costs continue to rise and Medicare Advantage rates not increase at a high rate (which was the case this year).
Although the company generally brings in plenty of free cash flow, there have been periods where its free cash flow after dividend payments has been negative. If that turns into a long-term trend, it could be a warning sign for investors that CVS' pursuit of growth and paying a high dividend may not be sustainable.
Fundamental Chart data by YCharts
Should you buy CVS Health stock?
CVS Health stock trades at a fairly modest 10 times trailing earnings right now, making it an incredibly cheap buy. And its dividend looks safe as CVS' financials remain in good shape, even with reduced guidance. While I wouldn't say this is a stock that you can forget about, it can still make for a good long-term investment.
Investors, however, should monitor CVS' free cash flow to ensure there is a sufficient buffer between that and the cash dividends the company pays out. Knowing that will be key in determining how aggressive CVS can be with respect to growth while also making dividend payments. If free cash flow doesn't remain strong, then the company may have to make some tough decisions.
Provided that you're OK with taking on some risk and uncertainty, CVS Health could make for an excellent stock to buy right now given its cheap valuation.
