Consider This Before Buying Graham Corporation (NYSE:GHM) For The 3.3% Dividend

Could Graham Corporation (NYSE:GHM) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

With Graham yielding 3.3% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We’d guess that plenty of investors have purchased it for the income. Remember though, given the recent drop in its share price, Graham’s yield will look higher, even though the market may now be expecting a decline in its long-term prospects. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.

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NYSE:GHM Historical Dividend Yield, March 21st 2020
NYSE:GHM Historical Dividend Yield, March 21st 2020

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 it reported a loss over the past 12 months, Graham currently pays a dividend. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

Unfortunately, while Graham pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it’s not ideal from a dividend perspective.

While the above analysis focuses on dividends relative to a company’s earnings, we do note Graham’s strong net cash position, which will let it pay larger dividends for a time, should it choose.

Consider getting our latest analysis on Graham’s financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Graham has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was US$0.08 in 2010, compared to US$0.44 last year. This works out to be a compound annual growth rate (CAGR) of approximately 19% a year over that time.

Dividends have been growing pretty quickly, and even more impressively, they haven’t experienced any notable falls during this period.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Graham’s EPS have fallen by approximately 56% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Graham’s earnings per share, which support the dividend, have been anything but stable.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We’re a bit uncomfortable with Graham paying a dividend while loss-making, especially since the dividend was also not well covered by free cash flow. Second, earnings per share have actually shrunk, but at least the dividends have been relatively stable. There are a few too many issues for us to get comfortable with Graham from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we’ve picked out 2 warning signs for Graham that investors should take into consideration.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

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.

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. Thank you for reading.