Something To Consider Before Buying Southern Cross Electrical Engineering Limited (ASX:SXE) For The 5.7% Dividend

Could Southern Cross Electrical Engineering Limited (ASX:SXE) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. 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 Southern Cross Electrical Engineering yielding 5.7% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. 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 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. 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. Looking at the data, we can see that 68% of Southern Cross Electrical Engineering's profits were paid out as dividends in the last 12 months. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 122%, Southern Cross Electrical Engineering's dividend payments are poorly covered by cash flow. Southern Cross Electrical Engineering 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 Southern Cross Electrical Engineering to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

With a strong net cash balance, Southern Cross Electrical Engineering investors may not have much to worry about in the near term from a dividend perspective.

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. Southern Cross Electrical Engineering has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was AU$0.08 in 2009, compared to AU$0.03 last year. The dividend has shrunk at around 9.3% a year during that period. Southern Cross Electrical Engineering's dividend hasn't shrunk linearly at 9.3% per annum, but the CAGR is a useful estimate of the historical rate of change.

A shrinking dividend over a ten-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Southern Cross Electrical Engineering's earnings per share have shrunk at 16% 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 Southern Cross Electrical Engineering's 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. Southern Cross Electrical Engineering gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. Using these criteria, Southern Cross Electrical Engineering looks quite suboptimal from a dividend investment perspective.

Are management backing themselves to deliver performance? Check their shareholdings in Southern Cross Electrical Engineering in our latest insider ownership analysis.

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