Today we'll take a closer look at Convatec Group Plc (LON:CTEC) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.
Investors might not know much about Convatec Group's dividend prospects, even though it has been paying dividends for the last four years and offers a 2.1% yield. A 2.1% yield is not inspiring, but the longer payment history has some appeal. There are a few simple ways to reduce the risks of buying Convatec Group for its dividend, and we'll go through these below.
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. Convatec Group paid out 101% of its profit as dividends, over the trailing twelve month period. This is quite a high payout ratio that suggests the dividend is not well covered by earnings.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Convatec Group's cash payout ratio last year was 20%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's good to see that while Convatec Group's dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.
Consider getting our latest analysis on Convatec Group's financial position here.
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. Convatec Group has been paying a dividend for the past four years. The dividend has not fluctuated much, but with a relatively short payment history, we can't be sure this is sustainable across a full market cycle. During the past four-year period, the first annual payment was US$0.03 in 2017, compared to US$0.06 last year. Dividends per share have grown at approximately 19% per year over this time.
Convatec Group has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. It's good to see Convatec Group has been growing its earnings per share at 72% a year over the past five years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in dividends. Generally, a company that is growing rapidly while paying out a majority of its earnings, is seeing its debt burden increase. We'd be conscious of any extra risk added by this practice.
To summarise, shareholders should always check that Convatec Group's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're not keen on the fact that Convatec Group paid out such a high percentage of its income, although its cashflow is in better shape. 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 Convatec Group out there.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we've picked out 2 warning signs for Convatec Group that investors should take into consideration.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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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