Something To Consider Before Buying Fras-le S.A. (BVMF:FRAS3) For The 7.8% Dividend

Is Fras-le S.A. (BVMF:FRAS3) 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.

With Fras-le yielding 7.8% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. Remember though, due to the recent spike in its share price, Fras-le's yield will look lower, even though the market may now be factoring in an improvement 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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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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Fras-le paid out 390% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Fras-le's cash payout ratio in the last year was 26%, which suggests dividends were well covered by cash generated by the business. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Fras-le fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Consider getting our latest analysis on Fras-le's financial position here.

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. Fras-le has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was R$0.1 in 2010, compared to R$0.4 last year. This works out to be a compound annual growth rate (CAGR) of approximately 14% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Fras-le's EPS have fallen by approximately 25% 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 Fras-le's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Fras-le's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. In summary, Fras-le has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

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. To that end, Fras-le has 5 warning signs (and 1 which is potentially serious) we think you should know about.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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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