Should ARB Corporation Limited (ASX:ARB) Be Part Of Your Dividend Portfolio?

Is ARB Corporation Limited (ASX:ARB) 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.

A 2.1% yield is nothing to get excited about, but investors probably think the long payment history suggests ARB has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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ASX:ARB Historical Dividend Yield, September 14th 2019
ASX:ARB Historical Dividend Yield, September 14th 2019

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. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. ARB paid out 55% of its profit as dividends, over the trailing twelve month period. 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. ARB paid out 106% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. ARB paid out less in dividends than it reported in profits, but unfortunately it didn’t generate enough free cash flow to cover the dividend. Cash is king, as they say, and were ARB to repeatedly pay dividends that aren’t well covered by cashflow, we would consider this a warning sign.

While the above analysis focuses on dividends relative to a company’s earnings, we do note ARB’s strong net cash position, which will let it pay larger dividends for a time, should it choose.

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. For the purpose of this article, we only scrutinise the last decade of ARB’s dividend payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was AU$0.15 in 2009, compared to AU$0.40 last year. Dividends per share have grown at approximately 9.8% per year over this time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

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. ARB has grown its earnings per share at 4.1% per annum over the past five years. Growth of 4.1% is relatively anaemic growth, which we wonder about. If the company is struggling to grow, perhaps that’s why it elects to pay out more than half of its earnings to shareholders.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. 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. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. While we’re not hugely bearish on it, overall we think there are potentially better dividend stocks than ARB out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 7 ARB analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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. Thank you for reading.