Read This Before Buying Rede Energia Participações S.A. (BVMF:REDE3) For Its Dividend

Is Rede Energia Participações S.A. (BVMF:REDE3) 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.

Investors might not know much about Rede Energia Participações's dividend prospects, even though it has been paying dividends for the last five years and offers a 1.6% yield. A 1.6% yield is not inspiring, but the longer payment history has some appeal. Some simple research can reduce the risk of buying Rede Energia Participações for its dividend - read on to learn more.

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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, Rede Energia Participações paid out 141% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Rede Energia Participações' cash payout ratio last year was 14%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Rede Energia Participações fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Consider getting our latest analysis on Rede Energia Participações' 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. Looking at the data, we can see that Rede Energia Participações has been paying a dividend for the past five years. During the past five-year period, the first annual payment was R$0.06 in 2016, compared to R$0.2 last year. Dividends per share have grown at approximately 26% per year over this time. Rede Energia Participações' dividend payments have fluctuated, so it hasn't grown 26% 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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Rede Energia Participações has grown its earnings per share at 37% per annum over the past five years. The company has been growing its EPS at a very rapid rate, while paying out virtually all of its income as dividends. Generally, a company that is growing rapidly while paying out a majority of its earnings, is seeing its debt burden increase. We'd be conscious of any extra risk added by this practice.

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 not keen on the fact that Rede Energia Participações paid out such a high percentage of its income, although its cashflow is in better shape. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Rede Energia Participações out there.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. However, there are other things to consider for investors when analysing stock performance. Taking the debate a bit further, we've identified 3 warning signs for Rede Energia Participações that investors need to be conscious of moving forward.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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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