Zooming in on VTX:PM's 2.2% Dividend Yield

Dividend paying stocks like Phoenix Mecano AG (VTX:PM) 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 the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

While Phoenix Mecano's 2.2% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple analysis can reduce the risk of holding Phoenix Mecano for its dividend, and we'll focus on the most important aspects below.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Phoenix Mecano paid out 230% 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. Phoenix Mecano paid out 57% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Phoenix Mecano fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

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

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. Phoenix Mecano 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 €6.8 in 2010, compared to €9.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.0% a year over that time. Phoenix Mecano's dividend payments have fluctuated, so it hasn't grown 3.0% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Phoenix Mecano's earnings per share have shrunk at 28% a year over the past five years. 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.

Conclusion

To summarise, shareholders should always check that Phoenix Mecano'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 not keen on the fact that Phoenix Mecano paid out such a high percentage of its income, although its cashflow is in better shape. Earnings per share are down, and Phoenix Mecano's dividend has been cut at least once in the past, which is disappointing. Using these criteria, Phoenix Mecano looks quite suboptimal from a dividend investment perspective.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. As an example, we've identified 4 warning signs for Phoenix Mecano that you should be aware of before investing.

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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