Should Servcorp Limited (ASX:SRV) Be Part Of Your Income Portfolio?

Is Servcorp Limited (ASX:SRV) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

With Servcorp yielding 6.2% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. That said, the recent jump in the share price will make Servcorp's dividend yield look smaller, even though the company prospects could be improving. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on Servcorp!

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. 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 279% of Servcorp's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Servcorp's cash payout ratio last year was 11%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's good to see that while Servcorp's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

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

Remember, you can always get a snapshot of Servcorp's latest financial position, by checking our visualisation of its financial health.

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. For the purpose of this article, we only scrutinise the last decade of Servcorp'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 2010, compared to AU$0.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.2% a year over that time. Servcorp's dividend payments have fluctuated, so it hasn't grown 7.2% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Servcorp might have put its house in order since then, but we remain cautious.

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. Over the past five years, it looks as though Servcorp's EPS have declined at around 27% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Servcorp's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Servcorp's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. With this information in mind, we think Servcorp may not be an ideal dividend stock.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. As an example, we've identified 3 warning signs for Servcorp that you should be aware of before investing.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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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