Dividend paying stocks like Mayfield Childcare Limited (ASX:MFD) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
With only a three-year payment history, and a 2.2% yield, investors probably think Mayfield Childcare is not much of a dividend stock. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. Some simple analysis can reduce the risk of holding Mayfield Childcare for its dividend, and we'll focus on the most important aspects below.
Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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 17% of Mayfield Childcare's profits were paid out as dividends in the last 12 months. We'd say its dividends are thoroughly covered by earnings.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Mayfield Childcare's cash payout ratio last year was 23%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.
We update our data on Mayfield Childcare every 24 hours, so you can always get our latest analysis of its financial health, here.
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. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past three-year period, the first annual payment was AU$0.08 in 2018, compared to AU$0.02 last year. This works out to a decline of approximately 74% over that time.
A shrinking dividend over a three-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
Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. It's good to see Mayfield Childcare has been growing its earnings per share at 24% a year over the past five years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.
To summarise, shareholders should always check that Mayfield Childcare's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Mayfield Childcare is paying out a low percentage of its earnings and cash flow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Overall we think Mayfield Childcare scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.
It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we've picked out 2 warning signs for Mayfield Childcare that investors should take into consideration.
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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