Dividend paying stocks like The Scottish Investment Trust PLC (LON:SCIN) 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. 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.
In this case, Scottish Investment Trust likely looks attractive to investors, given its 3.3% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. The company also bought back stock equivalent to around 1.5% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Scottish Investment Trust for its dividend, and we'll go through these below.
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. While Scottish Investment Trust pays a dividend, it reported a loss over the last year. When a financial business is loss-making and pays a dividend, the dividend is not covered by profits. Its important that investors assess the quality of the company's assets and whether it can return to generating a positive income.
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. Scottish Investment Trust has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was UK£0.1 in 2011, compared to UK£0.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.7% a year over that time. The dividends haven't grown at precisely 8.7% every year, but this is a useful way to average out the historical rate of growth.
It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Scottish Investment Trust might have put its house in order since then, but we remain cautious.
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. Scottish Investment Trust's earnings per share have shrunk at 49% a year over the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.
To summarise, shareholders should always check that Scottish Investment Trust's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Scottish Investment Trust is paying out a dividend despite reporting a loss; clearly a concern. 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, Scottish Investment Trust looks suboptimal from a dividend investment perspective.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. To that end, Scottish Investment Trust has 3 warning signs (and 2 which can't be ignored) 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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