Read This Before Buying The Swatch Group AG (VTX:UHR) For Its Dividend

Dividend paying stocks like The Swatch Group AG (VTX:UHR) 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 1.3% yield is nothing to get excited about, but investors probably think the long payment history suggests Swatch Group has some staying power. Some simple research can reduce the risk of buying Swatch Group for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on Swatch Group!

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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. While Swatch Group pays a dividend, it reported a loss over the last year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

Of the free cash flow it generated last year, Swatch Group paid out 48% as dividends, suggesting the dividend is affordable.

While the above analysis focuses on dividends relative to a company's earnings, we do note Swatch Group's strong net cash position, which will let it pay larger dividends for a time, should it choose.

Remember, you can always get a snapshot of Swatch Group'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. Swatch Group has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was CHF5.0 in 2011, compared to CHF3.5 last year. This works out to be a decline of approximately 3.5% per year over that time. Swatch Group's dividend has been cut sharply at least once, so it hasn't fallen by 3.5% every year, but this is a decent approximation of the long term change.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

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. Over the past five years, it looks as though Swatch Group's EPS have declined at around 19% 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.

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. We're a bit uncomfortable with the company paying a dividend while being loss-making, although at least the dividend was covered by free cash flow. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. Overall, Swatch Group falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from competition or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 20 analysts we track are forecasting for the future.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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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