Today we’ll take a closer look at California Water Service Group (NYSE:CWT) from a dividend investor’s perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.
While California Water Service Group’s 1.6% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple research can reduce the risk of buying California Water Service Group for its dividend – read on to learn more.
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 56% of California Water Service Group’s profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Unfortunately, while California Water Service Group 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.
Is California Water Service Group’s Balance Sheet Risky?
As California Water Service Group 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 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. California Water Service Group has net debt of 4.45 times its EBITDA, which is getting towards the limit of most investors’ comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. With EBIT of 2.65 times its interest expense, California Water Service Group’s interest cover is starting to look a bit thin.
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. California Water Service Group has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 US$0.59 in 2010, compared to US$0.85 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.7% a year over that time.
Slow and steady dividend growth might not sound that exciting, but dividends have been stable for ten years, which we think is seriously impressive.
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. California Water Service Group has grown its earnings per share at 6.5% per annum over the past five years. 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.
To summarise, shareholders should always check that California Water Service Group’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. In sum, we find it hard to get excited about California Water Service Group from a dividend perspective. It’s not that we think it’s a bad business; just that there are other companies that perform better on these criteria.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 4 analysts we track are forecasting for California Water Service Group for free with public analyst estimates for the company.
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 email@example.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.
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