Here's How We Evaluate Cabot Microelectronics Corporation's (NASDAQ:CCMP) Dividend

Could Cabot Microelectronics Corporation (NASDAQ:CCMP) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a 1.2% yield and a five-year payment history, investors probably think Cabot Microelectronics looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. The company also bought back stock during the year, equivalent to approximately 0.6% of the company's market capitalisation at the time. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Cabot Microelectronics!

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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. Looking at the data, we can see that 58% of Cabot Microelectronics' profits were paid out as dividends in the last 12 months. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Cabot Microelectronics paid out a conservative 38% of its free cash flow as dividends last year. It's positive to see that Cabot Microelectronics' dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Is Cabot Microelectronics' Balance Sheet Risky?

As Cabot Microelectronics has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). Cabot Microelectronics has net debt of 2.01 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. Cabot Microelectronics has EBIT of 5.67 times its interest expense, which we think is adequate.

Remember, you can always get a snapshot of Cabot Microelectronics' 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. Looking at the data, we can see that Cabot Microelectronics has been paying a dividend for the past five years. During the past five-year period, the first annual payment was US$0.7 in 2015, compared to US$1.8 last year. Dividends per share have grown at approximately 20% per year over this time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

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. Earnings have grown at around 6.7% a year for the past five years, which is better than seeing them shrink! The rate at which earnings have grown is quite decent, and by paying out more than half of its earnings as dividends, the company is striking a reasonable balance between reinvestment and returns to shareholders.

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. Cabot Microelectronics' payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we'd like. Ultimately, Cabot Microelectronics comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we've picked out 4 warning signs for Cabot Microelectronics that investors should take into consideration.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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