Dividend paying stocks like Exchange Income Corporation (TSE:EIF) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.
A high yield and a long history of paying dividends is an appealing combination for Exchange Income. We'd guess that plenty of investors have purchased it for the income. There are a few simple ways to reduce the risks of buying Exchange Income for its dividend, and we'll go through these below.
Explore this interactive chart for our latest analysis on Exchange Income!
Payout ratios
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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Exchange Income paid out 198% 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.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 90%, Exchange Income's dividend payments are poorly covered by cash flow. Cash is slightly more important than profit from a dividend perspective, but given Exchange Income'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 Exchange Income's latest financial position, by checking our visualisation of its financial health.
Dividend Volatility
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of Exchange Income'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$1.6 in 2010, compared to CA$2.3 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.9% a year over that time.
Dividends have grown relatively slowly, which is not great, but some investors may value the relative consistency of the dividend.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. It's good to see Exchange Income has been growing its earnings per share at 16% a year over the past five years. Paying out more in dividends than was reported as profit can make sense in some cases, we would be inclined to avoid a company doing this, unless there were a solid reason.
We'd also point out that Exchange Income issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.
Conclusion
To summarise, shareholders should always check that Exchange Income'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 Exchange Income 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, Exchange Income 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.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. To that end, Exchange Income has 4 warning signs (and 1 which doesn't sit too well with us) 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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