Here's How We Evaluate Empresas Lipigas S.A.'s (SNSE:LIPIGAS) Dividend

Is Empresas Lipigas S.A. (SNSE:LIPIGAS) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Empresas Lipigas is a new dividend aristocrat in the making. We'd agree the yield does look enticing. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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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. In the last year, Empresas Lipigas paid out 28% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Empresas Lipigas paid out 53% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's positive to see that Empresas Lipigas' dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Consider getting our latest analysis on Empresas Lipigas' financial position here.

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. Empresas Lipigas has been paying a dividend for the past four years. This company's dividend has been unstable, and with a relatively short history, we think it's a little soon to draw strong conclusions about its long term dividend potential. During the past four-year period, the first annual payment was CL$317 in 2017, compared to CL$281 last year. This works out to be a decline of approximately 3.0% per year over that time. Empresas Lipigas' dividend hasn't shrunk linearly at 3.0% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying Empresas Lipigas for its dividend, given that payments have shrunk over the past four years.

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? While there may be fluctuations in the past , Empresas Lipigas' earnings per share have basically not grown from where they were five years ago. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. Empresas Lipigas is paying out less than half of its earnings, which we like. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.

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. Above all, we're glad to see that Empresas Lipigas pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. In sum, we find it hard to get excited about Empresas Lipigas from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've picked out 2 warning signs for Empresas Lipigas that investors should know about before committing capital to this stock.

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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