Are Dividend Investors Making A Mistake With Adelaide Brighton Limited (ASX:ABC)?

Could Adelaide Brighton Limited (ASX:ABC) 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.

A high yield and a long history of paying dividends is an appealing combination for Adelaide Brighton. It would not be a surprise to discover that many investors buy it for the dividends. Some simple research can reduce the risk of buying Adelaide Brighton for its dividend – read on to learn more.

Explore this interactive chart for our latest analysis on Adelaide Brighton!

ASX:ABC Historical Dividend Yield, August 17th 2019
ASX:ABC Historical Dividend Yield, August 17th 2019

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. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Adelaide Brighton paid out 70% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.

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 103%, Adelaide Brighton’s dividend payments are poorly covered by cash flow. While Adelaide Brighton’s dividends were covered by the company’s reported profits, free cash flow is somewhat more important, so it’s not great to see that the company didn’t generate enough cash to pay its dividend. Cash is king, as they say, and were Adelaide Brighton to repeatedly pay dividends that aren’t well covered by cashflow, we would consider this a warning sign.

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. Adelaide Brighton has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was AU$0.19 in 2009, compared to AU$0.28 last year. Dividends per share have grown at approximately 4.0% per year over this time. The dividends haven’t grown at precisely 4.0% 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? Earnings have grown at around 3.8% a year for the past five years, which is better than seeing them shrink! 3.8% per annum is not a particularly high rate of growth, which we find curious. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.

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. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Unfortunately, the company has not been able to generate earnings per share growth, and cut its dividend at least once in the past. Overall, Adelaide Brighton falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 8 Adelaide Brighton analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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.