Three Things You Should Check Before Buying Cerillion Plc (LON:CER) For Its Dividend

Dividend paying stocks like Cerillion Plc (LON:CER) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

With a 1.3% yield and a five-year payment history, investors probably think Cerillion looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. Remember though, due to the recent spike in its share price, Cerillion's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. Some simple research can reduce the risk of buying Cerillion for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, Cerillion paid out 62% 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Cerillion paid out 29% as dividends, suggesting the dividend is affordable. It's positive to see that Cerillion's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

While the above analysis focuses on dividends relative to a company's earnings, we do note Cerillion's strong net cash position, which will let it pay larger dividends for a time, should it choose.

We update our data on Cerillion every 24 hours, so you can always get our latest analysis of its financial health, 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. Cerillion has been paying a dividend for the past five years. During the past five-year period, the first annual payment was UK£0.03 in 2016, compared to UK£0.06 last year. This works out to be a compound annual growth rate (CAGR) of approximately 16% a year over that time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

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. Over the past five years, it looks as though Cerillion's EPS have declined at around 72% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Cerillion's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Cerillion's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Cerillion has an acceptable payout ratio and its dividend is well covered by cashflow. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. Ultimately, Cerillion comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've picked out 1 warning sign for Cerillion that investors should know about before committing capital to this stock.

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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