Tread With Caution Around Adacel Technologies Limited's (ASX:ADA) 3.6% Dividend Yield

Dividend paying stocks like Adacel Technologies Limited (ASX:ADA) 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 your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

With a five-year payment history and a 3.6% yield, many investors probably find Adacel Technologies intriguing. It sure looks interesting on these metrics - but there's always more to the story. The company also bought back stock equivalent to around 0.6% of market capitalisation this year. Remember though, due to the recent spike in its share price, Adacel Technologies's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

Click the interactive chart for our full dividend analysis

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Although Adacel Technologies pays a dividend, it was loss-making during the past year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

Adacel Technologies paid out 143% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term.

With a strong net cash balance, Adacel Technologies investors may not have much to worry about in the near term from a dividend perspective.

We update our data on Adacel Technologies every 24 hours, so you can always get our latest analysis of its financial health, 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. Adacel Technologies has been paying a dividend for the past five years. During the past five-year period, the first annual payment was AU$0.01 in 2015, compared to AU$0.02 last year. Dividends per share have grown at approximately 5.9% per year over this time. Adacel Technologies' dividend payments have fluctuated, so it hasn't grown 5.9% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Dividends have grown at a reasonable rate, but with at least one substantial cut in the payments, we're not certain this dividend stock would be ideal for someone intending to live on the income.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Adacel Technologies' earnings per share have shrunk at 14% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Adacel Technologies' earnings per share, which support the dividend, have been anything but stable.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. It's a concern to see that the company paid a dividend despite reporting a loss, and the dividend was also not well covered by free cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. There are a few too many issues for us to get comfortable with Adacel Technologies from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Case in point: We've spotted 4 warning signs for Adacel Technologies (of which 1 shouldn't be ignored!) you should know about.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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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