Is Arad Ltd. (TLV:ARD) A Smart Choice For Dividend Investors?

Dividend paying stocks like Arad Ltd. (TLV:ARD) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

A 1.4% yield is nothing to get excited about, but investors probably think the long payment history suggests Arad has some staying power. Some simple research can reduce the risk of buying Arad 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. 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 53% of Arad's profits were paid out as dividends in the last 12 months. 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.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Arad's cash payout ratio last year was 22%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. 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.

Remember, you can always get a snapshot of Arad's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

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. For the purpose of this article, we only scrutinise the last decade of Arad's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was US$0.2 in 2011, compared to US$0.2 last year. Dividend payments have grown at less than 1% a year over this period.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

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. Arad's earnings per share have been essentially flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. Growth of 0.7% is relatively anaemic growth, which we wonder about. When a business is not growing, it often makes more sense to pay higher dividends to shareholders rather than retain the cash with no way to utilise it.

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. First, we think Arad has an acceptable payout ratio and its dividend is well covered by cashflow. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. Ultimately, Arad 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.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 1 warning sign for Arad that investors need to be conscious of moving forward.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

If you decide to trade Arad, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.