Are Dividend Investors Making A Mistake With Direcional Engenharia S.A. (BVMF:DIRR3)?

Is Direcional Engenharia S.A. (BVMF:DIRR3) 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 Direcional Engenharia yielding 6.0% 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. The company also bought back stock equivalent to around 1.2% of market capitalisation this year. Some simple research can reduce the risk of buying Direcional Engenharia for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on Direcional Engenharia!

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. 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 106% of Direcional Engenharia'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. Direcional Engenharia's cash payout ratio in the last year was 46%, which suggests dividends were well covered by cash generated by the business. It's good to see that while Direcional Engenharia'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.

We update our data on Direcional Engenharia every 24 hours, so you can always get our latest analysis of its financial health, 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. For the purpose of this article, we only scrutinise the last decade of Direcional Engenharia's dividend payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was R$0.3 in 2011, compared to R$0.8 last year. This works out to be a compound annual growth rate (CAGR) of approximately 10% a year over that time. Direcional Engenharia's dividend payments have fluctuated, so it hasn't grown 10% every year, but the CAGR is a useful rule of thumb for approximating the historical 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. Direcional Engenharia's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation.

Conclusion

To summarise, shareholders should always check that Direcional Engenharia'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 not keen on the fact that Direcional Engenharia paid out such a high percentage of its income, although its cashflow is in better shape. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. In summary, Direcional Engenharia has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 2 warning signs for Direcional Engenharia that investors need to be conscious of moving forward.

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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