Read This Before Buying Australian Finance Group Limited (ASX:AFG) For Its Dividend

Dividend paying stocks like Australian Finance Group Limited (ASX:AFG) 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 the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

In this case, Australian Finance Group likely looks attractive to dividend investors, given its 7.1% dividend yield and five-year payment history. It sure looks interesting on these metrics - but there's always more to the story. Some simple research can reduce the risk of buying Australian Finance Group for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on Australian Finance Group!

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. In the last year, Australian Finance Group paid out 70% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

Consider getting our latest analysis on Australian Finance Group's financial position here.

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. Australian Finance Group has been paying a dividend for the past five years. During the past five-year period, the first annual payment was AU$0.04 in 2015, compared to AU$0.1 last year. Dividends per share have grown at approximately 22% per year over this time. The dividends haven't grown at precisely 22% every year, but this is a useful way to average out the historical rate of growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

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. It's good to see Australian Finance Group has been growing its earnings per share at 13% a year over the past five years. Earnings per share have been growing rapidly, but given that it is paying out more than half of its earnings as dividends, we wonder how Australian Finance Group will keep funding its growth projects in the future.

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. Australian Finance Group's payout ratio is within an average range for most market participants. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Australian Finance Group might not be a bad business, but it doesn't show all of the characteristics we look for in a dividend stock.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. For example, we've picked out 3 warning signs for Australian Finance Group that investors should know about before committing capital to this stock.

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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