Does Inversiones Aguas Metropolitanas S.A. (SNSE:IAM) Have A Place In Your Dividend Stock Portfolio?

Dividend paying stocks like Inversiones Aguas Metropolitanas S.A. (SNSE:IAM) 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 Inversiones Aguas Metropolitanas. It would not be a surprise to discover that many investors buy it for the dividends. There are a few simple ways to reduce the risks of buying Inversiones Aguas Metropolitanas for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Inversiones Aguas Metropolitanas!

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. Looking at the data, we can see that 82% of Inversiones Aguas Metropolitanas' profits were paid out as dividends in the last 12 months. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Inversiones Aguas Metropolitanas paid out 328% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. Inversiones Aguas Metropolitanas paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Inversiones Aguas Metropolitanas to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Consider getting our latest analysis on Inversiones Aguas Metropolitanas' financial position here.

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. For the purpose of this article, we only scrutinise the last decade of Inversiones Aguas Metropolitanas' dividend 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 CL$60.7 in 2011, compared to CL$52.3 last year. This works out to be a decline of approximately 1.5% per year over that time. Inversiones Aguas Metropolitanas' dividend hasn't shrunk linearly at 1.5% per annum, but the CAGR is a useful estimate of the historical rate of change.

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

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. Inversiones Aguas Metropolitanas' earnings per share have shrunk at 10% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Inversiones Aguas Metropolitanas' earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Inversiones Aguas Metropolitanas' dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Inversiones Aguas Metropolitanas gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. Using these criteria, Inversiones Aguas Metropolitanas looks quite suboptimal from a dividend investment perspective.

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. To that end, Inversiones Aguas Metropolitanas has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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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