Are Dividend Investors Getting More Than They Bargained For With Challenger Limited's (ASX:CGF) Dividend?

Is Challenger Limited (ASX:CGF) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

A 3.0% yield is nothing to get excited about, but investors probably think the long payment history suggests Challenger has some staying power. There are a few simple ways to reduce the risks of buying Challenger for its dividend, and we'll go through these below.

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Payout ratios

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. Although Challenger pays a dividend, it was loss-making during the past year. When a financial business is loss-making and pays a dividend, the dividend is not covered by profits. Its important that investors assess the quality of the company's assets and whether it can return to generating a positive income.

Consider getting our latest analysis on Challenger'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. For the purpose of this article, we only scrutinise the last decade of Challenger's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was AU$0.1 in 2011, compared to AU$0.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.7% a year over that time. The dividends haven't grown at precisely 2.7% every year, but this is a useful way to average out the historical rate of growth.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Challenger's earnings per share have shrunk at 36% a year over the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

We'd also point out that Challenger issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

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. We're a bit uncomfortable with it paying a dividend while reporting a loss over the past year. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. In short, we're not keen on Challenger from a dividend perspective. Businesses can change, but we've spotted a few too many concerns with this one to get comfortable.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. However, there are other things to consider for investors when analysing stock performance. To that end, Challenger has 3 warning signs (and 1 which is potentially serious) we think you should know about.

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