Is Waterco Limited (ASX:WAT) The Right Choice For A Smart Dividend Investor?

Today we'll take a closer look at Waterco Limited (ASX:WAT) 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. 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.

A 1.7% yield is nothing to get excited about, but investors probably think the long payment history suggests Waterco has some staying power. The company also bought back stock during the year, equivalent to approximately 1.7% of the company's market capitalisation at the time. Some simple analysis can reduce the risk of holding Waterco for its dividend, and we'll focus on the most important aspects 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. Waterco paid out 57% of its profit as dividends, over the trailing twelve month period. 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.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Waterco's cash payout ratio last year was 18%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's positive to see that Waterco's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Consider getting our latest analysis on Waterco's financial position 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. Waterco has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was AU$0.06 in 2010, compared to AU$0.05 last year. This works out to be a decline of approximately 1.8% per year over that time. Waterco's dividend has been cut sharply at least once, so it hasn't fallen by 1.8% every year, but this is a decent approximation of the long term change.

A shrinking dividend over a 10-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, 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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Waterco has grown its earnings per share at 16% per annum 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 Waterco will keep funding its growth projects in the future.

Conclusion

To summarise, shareholders should always check that Waterco's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Waterco has an acceptable payout ratio and its dividend is well covered by cashflow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Overall we think Waterco is an interesting dividend stock, although it could be better.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. As an example, we've identified 2 warning signs for Waterco that you should be aware of before investing.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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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