Consider This Before Buying Lovisa Holdings Limited (ASX:LOV) For The 2.8% Dividend

Today we'll take a closer look at Lovisa Holdings Limited (ASX:LOV) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

With a 2.8% yield and a six-year payment history, investors probably think Lovisa Holdings looks like a reliable dividend stock. A 2.8% yield is not inspiring, but the longer payment history has some appeal. Some simple analysis can reduce the risk of holding Lovisa Holdings for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Lovisa Holdings!

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Lovisa Holdings paid out 522% of its profit as dividends. 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. Lovisa Holdings' cash payout ratio last year was 24%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's good to see that while Lovisa Holdings' 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.

While the above analysis focuses on dividends relative to a company's earnings, we do note Lovisa Holdings' strong net cash position, which will let it pay larger dividends for a time, should it choose.

Consider getting our latest analysis on Lovisa Holdings' financial position here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. Looking at the data, we can see that Lovisa Holdings has been paying a dividend for the past six years. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past six-year period, the first annual payment was AU$0.08 in 2015, compared to AU$0.4 last year. This works out to be a compound annual growth rate (CAGR) of approximately 30% a year over that time. The dividends haven't grown at precisely 30% every year, but this is a useful way to average out the historical rate of growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

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. Lovisa Holdings' EPS have fallen by approximately 26% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Lovisa Holdings' earnings per share, which support the dividend, have been anything but stable.

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. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Earnings per share are down, and Lovisa Holdings' dividend has been cut at least once in the past, which is disappointing. With this information in mind, we think Lovisa Holdings may not be an ideal dividend stock.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we've picked out 5 warning signs for Lovisa Holdings that investors should take into consideration.

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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