Tread With Caution Around Hindustan Composites Limited's (NSE:HINDCOMPOS) 0.7% Dividend Yield

Today we'll take a closer look at Hindustan Composites Limited (NSE:HINDCOMPOS) 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. 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 slim 0.7% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Hindustan Composites could have potential. Some simple research can reduce the risk of buying Hindustan Composites for its dividend - read on to learn more.

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Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Hindustan Composites paid out 18% of its profit as dividends, over the trailing twelve month period. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Hindustan Composites paid out 140% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While Hindustan Composites' dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Hindustan Composites' ability to maintain its dividend.

With a strong net cash balance, Hindustan Composites investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on Hindustan Composites' financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of Hindustan Composites' dividend payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was ₹3.3 in 2011, compared to ₹2.0 last year. This works out to be a decline of approximately 5.0% per year over that time. Hindustan Composites' dividend hasn't shrunk linearly at 5.0% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying Hindustan Composites for its dividend, given that payments have shrunk over the past 10 years.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Hindustan Composites' earnings per share have shrunk at 10% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Hindustan Composites' earnings per share, which support the dividend, have been anything but stable.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Firstly, the company has a conservative payout ratio, although we'd note that its cashflow in the past year was substantially lower than its reported profit. Earnings per share are down, and Hindustan Composites' dividend has been cut at least once in the past, which is disappointing. In summary, Hindustan Composites has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Just as an example, we've come accross 5 warning signs for Hindustan Composites you should be aware of, and 1 of them is potentially serious.

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