Is Link Administration Holdings Limited's (ASX:LNK) 4.4% Dividend Worth Your Time?

Is Link Administration Holdings Limited (ASX:LNK) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

In this case, Link Administration Holdings likely looks attractive to dividend investors, given its 4.4% dividend yield and four-year payment history. It sure looks interesting on these metrics - but there's always more to the story. The company also bought back stock equivalent to around 0.9% of market capitalisation this year. Some simple analysis can reduce the risk of holding Link Administration Holdings for its dividend, and we'll focus on the most important aspects below.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Link Administration Holdings paid out 63% of its profit as dividends, over the trailing twelve month period. 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. Link Administration Holdings paid out 66% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Consider getting our latest analysis on Link Administration Holdings' financial position here.

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. Looking at the data, we can see that Link Administration Holdings has been paying a dividend for the past four years. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past four-year period, the first annual payment was AU$0.08 in 2016, compared to AU$0.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 24% a year over that time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Link Administration Holdings has grown its earnings per share at 44% per annum over the past five years. With recent, rapid earnings per share growth and a payout ratio of 63%, this business looks like an interesting prospect if earnings are reinvested effectively.

Conclusion

To summarise, shareholders should always check that Link Administration Holdings' dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Link Administration Holdings' is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Link Administration Holdings out there.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For example, we've picked out 4 warning signs for Link Administration Holdings that investors should know about before committing capital to this stock.

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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