Are Dividend Investors Getting More Than They Bargained For With FAT Brands Inc.'s (NASDAQ:FAT) Dividend?

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Is FAT Brands Inc. (NASDAQ:FAT) a good dividend stock? How would you know? A dividend paying company with growing earnings can be rewarding in the long term. Unfortunately, one common occurrence with dividend companies is for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

Some readers mightn't know much about FAT Brands's 9.7% dividend, as it has only been paying distributions for a year or so. There are a few simple ways to reduce the risks of buying FAT Brands for its dividend, and we'll go through these below.

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. Although FAT Brands pays a dividend, it was loss-making during the past year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

With a loss in the last year, it becomes even more important to evaluate if the company is generating enough cash flow to pay its dividend and meet its obligations. The company paid out 52%, which is not bad per se, but does start to limit the amount of cash FAT Brands has available to meet other needs.

Is FAT Brands's Balance Sheet Risky?

Given FAT Brands is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). FAT Brands has net debt of 6.10 times its earnings before interest, tax, depreciation and amortisation (EBITDA) which implies meaningful risk if interest rates rise of earnings decline.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of less than 1 times its interest expense, FAT Brands's financial situation is potentially quite concerning. Readers should investigate whether it might be at risk of breaching the minimum requirements on its loans. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.

Remember, you can always get a snapshot of FAT Brands's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. This company has been paying a dividend for less than 2 years, which we think is too soon to consider it a reliable dividend stock. During the past one-year period, the first annual payment was US$0.47 in 2018, compared to US$0.48 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.1% a year over that time.

It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. FAT Brands's earnings per share have fallen -715% over the past year. This is a pretty serious concern, and it would be worth investigating whether something fundamental in the business has changed - or broken. Any one year of performance can be misleading for a variety of reasons, so we wouldn't like to form any strong conclusions based on these numbers alone.

We'd also point out that FAT Brands issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. We're not keen on the fact that FAT Brands paid out such a high percentage of its income, although its cashflow is in better shape. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. Using these criteria, FAT Brands looks quite suboptimal from a dividend investment perspective.

Now, if you want to look closer, it would be worth checking out our free research on FAT Brands management tenure, salary, and performance.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

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.

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. Thank you for reading.