Are Dividend Investors Getting More Than They Bargained For With Varroc Engineering Limited's (NSE:VARROC) Dividend?

Is Varroc Engineering Limited (NSE:VARROC) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

With only a two-year payment history, and a 0.6% yield, investors probably think Varroc Engineering is not much of a dividend stock. While it may not look like much, if earnings are growing it could become quite interesting. That said, the recent jump in the share price will make Varroc Engineering's dividend yield look smaller, even though the company prospects could be improving. Some simple analysis can reduce the risk of holding Varroc Engineering for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Varroc Engineering!

Payout ratios

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. While Varroc Engineering pays a dividend, it reported a loss over the last year. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Last year, Varroc Engineering paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

We update our data on Varroc Engineering every 24 hours, so you can always get our latest analysis of its financial health, 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. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past two-year period, the first annual payment was ₹4.0 in 2019, compared to ₹3.0 last year. This works out to a decline of approximately 25% over that time.

A shrinking dividend over a two-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Over the past five years, it looks as though Varroc Engineering's EPS have declined at around 45% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Varroc Engineering's 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. First, we like Varroc Engineering's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. 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. In summary, Varroc Engineering 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.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. As an example, we've identified 3 warning signs for Varroc Engineering that you should be aware of before investing.

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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