You can get decent investing results by collecting dividends from high-yielding stocks and reinvesting them to compound your gains. However, that strategy only works well as long as the stocks you buy and hold have sustainable dividends.
Is the 5%-plus dividend yield for pharmaceutical giant GlaxoSmithKline (LSE: GSK) sustainable? This table summarises the recent financial record:
Net cash from operations (£m)
Profit before tax (£m)
Adjusted earnings per share
Dividend per share
Cash flow generally supports profits well. But neither cash flow, earnings or the dividend have moved up over the past four years, suggesting that GlaxoSmithKline is struggling to grow.
Back in April with the first quarter results report, chief executive Emma Walmsley told us that the company made good progress in the first part of the year, with sales growth across all operational businesses. Recent product launches included Shingrix, Trelegy and Juluca, which, along with other new releases, are contributing to improvements in the firm's adjusted operating margin.
However, the problem of patent expiry still dogs the firm and sometimes it seems as if two steps back follow every two steps forward, as the recent stagnant dividend attests. The firm saw "increased pricing and competitive pressures" in the US inhaled respiratory market during the first quarter and expects a decline of around 30% in sales of Advair in the US during 2018. Overall, the directors think earnings per share will grow 4-7% this year, suggesting some progress, although probably not enough to get the dividend moving up again.
The company has agreed with Novartis to acquire its Consumer Healthcare business for $13bn, subject to shareholder approval. The directors said the acquisition will "improve future cash generation and support capital planning" with the aim of strengthening the pharmaceuticals business and the research and development (R&D) pipeline. I reckon boosting that R&D pipeline is the firm's best hope for getting the dividend to expand in the future, so the Novartis move could mark a turning point for GlaxoSmithKline.
GlaxoSmithKline's dividend sustainability score
Let's look at three different features to judge whether the company's dividend seems sustainable with each indicator scored out of a possible five points:
Dividend cover: adjusted earnings covered last year's dividend almost 1.4 times. 2/5
Cash flow: generally, cash flow covers profits well but has not grown in four years. 4/5
Outlook and trading: recent trading has been good and the outlook is satisfactory. 4/5
Overall, I score GlaxoSmithKline 10 out of 15, which makes me a little cautious about the sustainability of the firm's dividend, particularly with the ongoing drag from generic competition. The static dividend demonstrates how tough things have been for the firm and I'm not expecting the dividend to rise much over the next year or two. That said, I think GlaxoSmithKline could be a decent stock to hold for very patient investors because of the defensive characteristics of the sector.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.