Dividend paying stocks like The Weir Group PLC (LON:WEIR) tend to be popular with investors, and for good reason – some research suggests a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on the income from dividends, it’s important to be a lot more stringent with your investments than the average punter.
A high yield and a long history of paying dividends is an appealing combination for Weir Group. It would not be a surprise to discover that many investors buy it for the dividends. Some simple research can reduce the risk of buying Weir Group for its dividend – read on to learn more.
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Payout ratios
Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable – hardly an ideal situation. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. Weir Group paid out 183% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Last year, Weir Group paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is Weir Group’s Balance Sheet Risky?
As Weir Group’s dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company’s total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Weir Group has net debt of 2.96 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company’s net interest expense. Weir Group has EBIT of 7.00 times its interest expense, which we think is adequate.
Dividend Volatility
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Weir Group’s dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was UK£0.18 in 2009, compared to UK£0.46 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.6% a year over that time.
Businesses that can grow their dividends at a decent rate and maintain a stable payout can generate substantial wealth for shareholders over the long term.
Dividend Growth Potential
While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend’s purchasing power over the long term. Weir Group’s EPS have fallen by approximately 30% per year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.
Conclusion
To summarise, shareholders should always check that Weir Group’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Weir Group paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. Earnings per share have not been growing, but we respect a company that maintains a relatively stable dividend. There are a few too many issues for us to get comfortable with Weir Group from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.
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.