Dividend paying stocks like Mount Gibson Iron Limited (ASX:MGX) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A high yield and a long history of paying dividends is an appealing combination for Mount Gibson Iron. It would not be a surprise to discover that many investors buy it for the dividends. There are a few simple ways to reduce the risks of buying Mount Gibson Iron for its dividend, and we'll go through these below.
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 30% of Mount Gibson Iron's profits were paid out as dividends in the last 12 months. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Mount Gibson Iron's cash payout ratio in the last year was 30%, which suggests dividends were well covered by cash generated by the business. 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.
With a strong net cash balance, Mount Gibson Iron investors may not have much to worry about in the near term from a dividend perspective.
Remember, you can always get a snapshot of Mount Gibson Iron's latest financial position, by checking our visualisation of its financial health.
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. Mount Gibson Iron has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was AU$0.04 in 2011, compared to AU$0.03 last year. The dividend has shrunk at around 2.8% a year during that period. Mount Gibson Iron's dividend hasn't shrunk linearly at 2.8% per annum, but the CAGR is a useful estimate of the historical rate of change.
We struggle to make a case for buying Mount Gibson Iron for its dividend, given that payments have shrunk over the past 10 years.
Dividend Growth Potential
Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. It's good to see Mount Gibson Iron has been growing its earnings per share at 21% a year over the past five years. With high earnings per share growth in recent times and a modest payout ratio, we think this is an attractive combination if earnings can be reinvested to generate further growth.
To summarise, shareholders should always check that Mount Gibson Iron'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 Mount Gibson Iron 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. All things considered, Mount Gibson Iron looks like a strong prospect. At the right valuation, it could be something special.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Case in point: We've spotted 4 warning signs for Mount Gibson Iron (of which 1 shouldn't be ignored!) 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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