Is Morneau Shepell Inc. (TSE:MSI) The Right Choice For A Smart Dividend Investor?

Today we'll take a closer look at Morneau Shepell Inc. (TSE:MSI) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

A 2.6% yield is nothing to get excited about, but investors probably think the long payment history suggests Morneau Shepell has some staying power. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Morneau Shepell paid out 113% 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.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Morneau Shepell paid out 90% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Cash is slightly more important than profit from a dividend perspective, but given Morneau Shepell's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Remember, you can always get a snapshot of Morneau Shepell's latest financial position, by checking our visualisation of its financial health.

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 Morneau Shepell's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past 10-year period, the first annual payment was CA$0.9 in 2010, compared to CA$0.8 last year. This works out to be a decline of approximately 1.9% per year over that time.

A shrinking dividend over a 10-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. It's good to see Morneau Shepell has been growing its earnings per share at 19% a year over the past five years. With a payout ratio of 113%, Morneau Shepell is paying out substantially more than it earned in dividends. This is a risky practice.

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 Morneau Shepell paying out a high percentage of both its cashflow and earnings. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. Ultimately, Morneau Shepell comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

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. To that end, Morneau Shepell has 3 warning signs (and 1 which is potentially serious) we think you should know about.

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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