With interest rates still sitting near record lows, investors looking for current income have been forced to move from fixed-income positions and into stocks to find yield. To help offset those risks, one of the first things dividend investors do is look for companies operating in defensive industries like UnitedHealth Group (NYSE:UNH). But before doing the foolish thing and taking this dividend for granted, let's take a closer look at whether it's truly worthy of a spot in your portfolio.
Health is priceless; health care isn't.
As a health insurance company, UnitedHealth Group benefits from many of the unique elements of the industry that make it attractive for dividend investors. We all know it's impossible to put a price on one's health and well-being. Because of that, the health care sector at large is much less sensitive downturns in consumer spending. This dynamic, along with the aging and increasingly unhealthy society that we're all well aware of, is a key reason health care spending will continue to grow.
But while these big picture trends might be driving the overall industry, investors looking at specific health care dividend stocks need to dig a layer deeper to understand the company-specific issues at work. After all, dividends aren't a guarantee, and if the going gets tough enough, even a "stable" health care stock could cut -- or eliminate -- its dividend. With that being said, let's check on where UnitedHealth Group's dividend has been, and try to determine where it's going.
A quick-and-dirty technique for checking a dividend's sustainability is taking a look at something called the payout ratio. Typically this is expressed as a percentage, looking at a company's dividend per share relative to its net income per share. That's a decent start, but I prefer to use a slightly different measurement that replaces net income, an accounting measurement, with something more tangible -- cold hard cash. The chart below shows how much of UnitedHealth Group's free cash flow has been eaten up by its dividend payments over the past two years. The lower the better, suggesting more capacity for future dividend hikes.
Not all dividends are created equal. At first glance a high dividend yield may look nice, but all too often it means a problem is lurking around the corner for a business. Looking at UnitedHealth Group's 1.6% dividend yield in isolation only tells half of the story, which is why investors need to have an understanding of how the market perceives a company prior to buying a stock. We can do this by comparing a few financial multiples, like price to earnings, to its peers in the industry.
Up to this point, we've looked at UnitedHealth Group's dividend in the past, and we've also seen how its stock is being perceived by the market today. However, the most important factor to consider when understanding a dividend's future is where the company's cash flow is heading. It's hard to generate more cash without growing sales, so let's take a look at what industry analysts are expecting for UnitedHealth Group's revenue growth relative to peers this year.
With a low payout ratio, reasonable valuation, and long-term growth prospects solidified by Obamacare, UnitedHealth is a reliable dividend for the long term. But looking only at the dividend doesn't tell the complete story for investors.
Over the past year, about 30% of the company's earnings growth has come from share repurchases, something the company's been much more inclined to do recently versus distributing dividend payments. Taking both share repurchases and dividends together, the company spent about 64% of free cash flow returning funds to investors. That leaves a bit less room for dividend hikes than the payout ratio above suggests, but with the tailwinds of Obamacare at its back, there's no reason to think UnitedHealth Group won't boost its payout in the future.
Brenton Flynn has no position in any stocks mentioned. The Motley Fool recommends UnitedHealth Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.