Is Arezzo Indústria e Comércio S.A.'s (BVMF:ARZZ3) 1.3% Dividend Sustainable?

Dividend paying stocks like Arezzo Indústria e Comércio S.A. (BVMF:ARZZ3) 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.

Investors might not know much about Arezzo Indústria e Comércio's dividend prospects, even though it has been paying dividends for the last nine years and offers a 1.3% yield. A 1.3% yield is not inspiring, but the longer payment history has some appeal. There are a few simple ways to reduce the risks of buying Arezzo Indústria e Comércio for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Arezzo Indústria e Comércio!

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Arezzo Indústria e Comércio paid out 337% of its profit as dividends, over the trailing twelve month period. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Arezzo Indústria e Comércio paid out 60% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's good to see that while Arezzo Indústria e Comércio's dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

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

We update our data on Arezzo Indústria e Comércio every 24 hours, so you can always get our latest analysis of its financial health, 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 Arezzo Indústria e Comércio paid its first dividend at least nine years ago. 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 nine-year period, the first annual payment was R$0.2 in 2011, compared to R$0.9 last year. This works out to be a compound annual growth rate (CAGR) of approximately 19% a year over that time. The dividends haven't grown at precisely 19% 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

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? Arezzo Indústria e Comércio's earnings per share have shrunk at 24% 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

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. 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 Arezzo Indústria e Comércio's dividend has been cut at least once in the past, which is disappointing. There are a few too many issues for us to get comfortable with Arezzo Indústria e Comércio from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For example, we've identified 5 warning signs for Arezzo Indústria e Comércio (1 is a bit concerning!) 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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