Are Dividend Investors Making A Mistake With GR Engineering Services Limited (ASX:GNG)?

Dividend paying stocks like GR Engineering Services Limited (ASX:GNG) 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. 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.

In this case, GR Engineering Services likely looks attractive to dividend investors, given its 4.3% dividend yield and nine-year payment history. It sure looks interesting on these metrics - but there's always more to the story. That said, the recent jump in the share price will make GR Engineering Services's dividend yield look smaller, even though the company prospects could be improving. There are a few simple ways to reduce the risks of buying GR Engineering Services for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on GR Engineering Services!

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 it reported a loss over the past 12 months, GR Engineering Services currently pays a dividend. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

GR Engineering Services paid out 318% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely.

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

Consider getting our latest analysis on GR Engineering Services' financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the last decade of data, we can see that GR Engineering Services paid its first dividend at least nine years ago. It's good to see that GR Engineering Services has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was AU$0.08 in 2011, compared to AU$0.04 last year. This works out to be a decline of approximately 7.4% per year over that time. GR Engineering Services' dividend hasn't shrunk linearly at 7.4% per annum, but the CAGR is a useful estimate of the historical rate of change.

A shrinking dividend over a nine-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. GR Engineering Services' earnings per share have shrunk at 25% 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.

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. GR Engineering Services' dividend is not well covered by free cash flow, plus it paid a dividend while being unprofitable. 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 this analysis, GR Engineering Services doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Taking the debate a bit further, we've identified 2 warning signs for GR Engineering Services that investors need to be conscious of moving forward.

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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