Three Things You Should Check Before Buying Infomedia Ltd (ASX:IFM) For Its Dividend

Is Infomedia Ltd (ASX:IFM) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

A 2.7% yield is nothing to get excited about, but investors probably think the long payment history suggests Infomedia has some staying power. Some simple analysis can reduce the risk of holding Infomedia for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Infomedia!

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Infomedia paid out 81% of its profit as dividends, over the trailing twelve month period. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Infomedia paid out 93% of its free cash flow last year, which we think is concerning if cash flows do not improve. Infomedia paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Infomedia to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

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

Consider getting our latest analysis on Infomedia's financial position here.

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. Infomedia 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$0.02 in 2011, compared to AU$0.04 last year. Dividends per share have grown at approximately 6.0% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

A reasonable rate of dividend growth is good to see, but we're wary that the dividend history is not as solid as we'd like, having been cut at least once.

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? Infomedia has grown its earnings per share at 5.9% per annum over the past five years. Past earnings growth has been decent, but unless this is one of those rare businesses that can grow without additional capital investment or marketing spend, we'd generally expect the higher payout ratio to limit its future growth prospects.

We'd also point out that Infomedia issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

To summarise, shareholders should always check that Infomedia's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. 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, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. With this information in mind, we think Infomedia may not be an ideal dividend stock.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For instance, we've picked out 2 warning signs for Infomedia 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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