Three Things You Should Check Before Buying FRoSTA Aktiengesellschaft (FRA:NLM) For Its Dividend

Is FRoSTA Aktiengesellschaft (FRA:NLM) a good dividend stock? How would you know? A dividend paying company with growing earnings can be rewarding in the long term. 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.

With a 2.6% yield and a nine-year payment history, investors probably think FRoSTA looks like a reliable dividend stock. A 2.6% yield is not inspiring, but the longer payment history has some appeal. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we’ll go through this below.

Explore this interactive chart for our latest analysis on FRoSTA!
DB:NLM Historical Dividend Yield, April 29th 2019
DB:NLM Historical Dividend Yield, April 29th 2019

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. In the last year, FRoSTA paid out 55% of its profit as dividends. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. FRoSTA paid out 110% of its free cash last year. Cash flows can be lumpy, but paying out this much cash is not ideal.

Remember, you can always get a snapshot of FRoSTA’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. The first recorded dividend for FRoSTA, in the last decade, was nine years ago. The dividend has been quite stable over the past nine years, which is great to see – although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past nine-year period, the first annual payment was €0.75 in 2010, compared to €1.60 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.8% a year over that time.

The dividend has been growing at a reasonable rate, which we like. We’re conscious though that one of the best ways to detect a multi-decade consistent dividend payer, is to watch a company pay dividends for 20 years – a distinction FRoSTA has not achieved yet.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient’s purchasing power. It’s good to see FRoSTA has been growing its earnings per share at 10% a year over the past 5 years. FRoSTA’s earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we think FRoSTA has an acceptable payout ratio, although its dividend was not well covered by cashflow. We were also glad to see it growing earnings, although its dividend history is not as long as we’d like. While we’re not hugely bearish on it, overall we think there are potentially better dividend stocks than FRoSTA out there.

Are management backing themselves to deliver performance? Check their shareholdings in FRoSTA in our latest insider ownership analysis.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.