Why Dividend Hunters Love Fabasoft AG (ETR:FAA)

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Could Fabasoft AG (ETR:FAA) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.

With a 0.9% yield and a nine-year payment history, investors probably think Fabasoft looks like a reliable dividend stock. A 0.9% yield is not inspiring, but the longer payment history has some appeal. That said, the recent jump in the share price will make Fabasoft’s dividend yield look smaller, even though the company prospects could be improving. Some simple research can reduce the risk of buying Fabasoft for its dividend – read on to learn more.

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XTRA:FAA Historical Dividend Yield, May 28th 2019
XTRA:FAA Historical Dividend Yield, May 28th 2019

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. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 38% of Fabasoft’s profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Fabasoft’s cash payout ratio last year was 18%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It’s encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don’t drop precipitously.

Consider getting our latest analysis on Fabasoft’s 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. The first recorded dividend for Fabasoft, in the last decade, was nine years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once by more than 20%, and we’re cautious about the consistency of its dividend across a full economic cycle. During the past nine-year period, the first annual payment was €0.075 in 2010, compared to €0.18 last year. Dividends per share have grown at approximately 10% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

It’s not great to see that the payment has been cut in the past. We’re generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

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? It’s good to see Fabasoft has been growing its earnings per share at 82% a year over the past 5 years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.

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. Firstly, we like that Fabasoft has low and conservative payout ratios. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. All things considered, Fabasoft looks like a strong prospect. At the right valuation, it could be something special.

See if management have their own wealth at stake, by checking insider shareholdings in Fabasoft stock.

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