Dividend paying stocks like K-Bro Linen Inc. (TSE:KBL) 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.
A 2.9% yield is nothing to get excited about, but investors probably think the long payment history suggests K-Bro Linen has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. K-Bro Linen paid out 335% of its profit as dividends, over the trailing twelve month period. 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.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. K-Bro Linen's cash payout ratio in the last year was 34%, which suggests dividends were well covered by cash generated by the business. It's good to see that while K-Bro Linen'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.
Consider getting our latest analysis on K-Bro Linen's financial position here.
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. K-Bro Linen has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 CA$1.1 in 2011, compared to CA$1.2 last year. Dividend payments have grown at less than 1% a year over this period.
It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.
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. Over the past five years, it looks as though K-Bro Linen's EPS have declined at around 25% a year. 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.
To summarise, shareholders should always check that K-Bro Linen'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 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 K-Bro Linen's dividend has been cut at least once in the past, which is disappointing. In summary, K-Bro Linen 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.
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 K-Bro Linen that investors should take into consideration.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
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