A dividend is only as good as the strength of the business that's paying it. If a company isn't in strong financial shape, investors shouldn't expect the dividend to last.
Two stocks that income investors are showing some concern about right now are CVS Health (CVS +0.08%) and Comcast (CMCSA +0.00%). The concern stems from the fact that their payout ratios are alarmingly high, and both companies are coming off some tough earnings reports.
Are the dividends for these two companies in trouble? If not, does that make these two stocks good buys right now?
1. CVS Health
CVS is the largest retail pharmacy in the country (based on total locations). It also owns a massive health insurance business in Aetna. In 2022, it announced plans to acquire home health company Signify Health for $8 billion. And CVS is still looking for more deals as it also wants to get into primary care. For such a growth-oriented business, a dividend could potentially get in the way.
NYSE: CVS
Key Data Points
CVS currently offers a dividend that yields 2.6%, which is better than the S&P 500 average of 1.8%. But the payout ratio jumped to more than 90% after its latest earnings report and investors may be getting a little concerned.
CVS recently reported worse-than-usual earnings, which contributed to the percentage spike (the average payout ratio is closer to 40%). The company incurred one-time charges relating to opioid litigation ($5.2 billion) and a loss on the sale of an asset ($2.5 billion) that weighed down its financials last quarter, with a net loss of $3.4 billion for the period ending Sept. 30.
This is a good example of how payout ratio alone can be misleading and cause investors to overlook a relatively safe dividend stock like CVS. In terms of cash flow, the payout looks to be in fine shape. In the trailing 12 months, CVS' free cash flow of $19.5 billion is nearly seven times the $2.8 billion that the company paid out in dividends during that stretch.
CVS' dividend remains safe, and while the company has been aggressive in pursuing growth opportunities, it has strong enough cash flow where it doesn't have to slash its dividend in order to take on more acquisitions. Plus, with the stock trading at just 10 times its future profits (the S&P 500 average is 17), CVS also looks like a cheap buy right now.
2. Comcast
Telecom giant Comcast provides investors with an even better yield at 3.1%. And similar to CVS, its payout ratio is around 87% of earnings (its average is closer to 30%). Comcast's expansion into the streaming business also means that it too will have strong demands for cash as it competes with Netflix, Disney, and other big names in the industry.
NASDAQ: CMCSA
Key Data Points
Another similarity to CVS -- Comcast is coming off a brutal quarter. For the period ending Sept. 30, the company incurred a net loss of $4.6 billion (versus a profit of $4 billion a year ago). That's due to Comcast incurring a staggering $8.6 billion in impairment charges, which included goodwill, on its Sky segment. Sky focuses on the European markets, and its sales have been disappointing, with the segment's revenue totaling $4.3 billion last quarter and declining 15% year over year.
As bad as that is, the company's total revenue of $29.8 billion for the quarter was down only 1.5% from the prior-year period. Given Sky's struggles, that's a relatively positive performance for the overall Comcast business. Another positive is that free cash flow of $3.4 billion was 4.7% higher than it was a year ago.
While investors shouldn't ignore impairment charges, they are noncash items that don't impact the dividend, and typically, they are also nonrecurring. As a result, Comcast's dividend looks fine, because when looking at a cash basis, the payout is sound: Comcast's free cash has totaled $15.1 billion over the trailing 12 months versus dividend payments of $4.7 billion.
Comcast is a good option for income-oriented investors. And at less than 10 times future earnings, the stock is an even cheaper buy than CVS.
