Today we’ll take a closer look at Terra Firma Capital Corporation (CVE:TII) 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. 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.
Some readers mightn’t know much about Terra Firma Capital’s 3.5% dividend, as it has only been paying distributions for a year or so. The company also returned around 9.9% of its market capitalisation to shareholders in the form of stock buybacks over the past year. There are a few simple ways to reduce the risks of buying Terra Firma Capital for its dividend, and we’ll go through these below.
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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. In the last year, Terra Firma Capital paid out 5.4% of its profit as dividends. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.
Remember, you can always get a snapshot of Terra Firma Capital’s latest financial position, by checking our visualisation of its financial health.
Dividend Volatility
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. This company has been paying a dividend for less than 2 years, which we think is too soon to consider it a reliable dividend stock. Its most recent annual dividend was US$0.15 per share.
Modest dividend growth is good to see, especially with the payments being relatively stable. However, the payment history is relatively short and we wouldn’t want to rely on this dividend too much.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient’s purchasing power. Terra Firma Capital has grown its earnings per share at 6.0% per annum over the past five years. A low payout ratio and strong historical earnings growth suggests Terra Firma Capital has been effectively reinvesting in its business. We think this generally bodes well for its dividend prospects.
Conclusion
To summarise, shareholders should always check that Terra Firma Capital’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 glad to see Terra Firma Capital has a low payout ratio, as this suggests earnings are being reinvested in the business. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we’d like. While we’re not hugely bearish on it, overall we think there are potentially better dividend stocks than Terra Firma Capital out there.
See if management have their own wealth at stake, by checking insider shareholdings in Terra Firma Capital stock.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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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