Would Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) Be Valuable To Income Investors?

Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

With Companhia de Saneamento Básico do Estado de São Paulo - SABESP yielding 3.5% 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. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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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. Companhia de Saneamento Básico do Estado de São Paulo - SABESP paid out 78% of its profit as dividends, over the trailing twelve month period. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. The company paid out 59% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Companhia de Saneamento Básico do Estado de São Paulo - SABESP has available to meet other needs. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

We update our data on Companhia de Saneamento Básico do Estado de São Paulo - SABESP every 24 hours, so you can always get our latest analysis of its financial health, 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. For the purpose of this article, we only scrutinise the last decade of Companhia de Saneamento Básico do Estado de São Paulo - SABESP's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was R$0.6 in 2011, compared to R$1.4 last year. Dividends per share have grown at approximately 9.1% per year over this time. Companhia de Saneamento Básico do Estado de São Paulo - SABESP's dividend payments have fluctuated, so it hasn't grown 9.1% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Companhia de Saneamento Básico do Estado de São Paulo - SABESP might have put its house in order since then, but we remain cautious.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in 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 Companhia de Saneamento Básico do Estado de São Paulo - SABESP has grown its earnings per share at 62% per annum over the past five years. The company pays out most of its earnings as dividends, although with such rapid EPS growth, its possible the dividend is better covered than it looks. Still, we'd be cautious about extrapolating high growth too far out into the future.

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. Companhia de Saneamento Básico do Estado de São Paulo - SABESP's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. In sum, we find it hard to get excited about Companhia de Saneamento Básico do Estado de São Paulo - SABESP from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we've picked out 3 warning signs for Companhia de Saneamento Básico do Estado de São Paulo - SABESP 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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