Stock Analysis

Is It Worth Buying Ultra Electronics Holdings plc (LON:ULE) For Its 2.7% Dividend Yield?

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LSE:ULE
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Is Ultra Electronics Holdings plc (LON:ULE) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly 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.

A slim 2.7% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Ultra Electronics Holdings could have potential. There are a few simple ways to reduce the risks of buying Ultra Electronics Holdings for its dividend, and we'll go through these below.

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LSE:ULE Historic Dividend January 14th 2021

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. In the last year, Ultra Electronics Holdings paid out 57% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Ultra Electronics Holdings paid out 9.0% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. 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 Ultra Electronics Holdings' 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 Ultra Electronics Holdings' dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past 10-year period, the first annual payment was UK£0.3 in 2011, compared to UK£0.5 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.7% a year over that time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Ultra Electronics Holdings has grown its earnings per share at 19% per annum over the past five years. Ultra Electronics Holdings' 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

To summarise, shareholders should always check that Ultra Electronics Holdings' dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Ultra Electronics Holdings' payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. All things considered, Ultra Electronics Holdings looks like a strong prospect. At the right valuation, it could be something special.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Earnings growth generally bodes well for the future value of company dividend payments. See if the 7 Ultra Electronics Holdings analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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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