Zooming in on NSE:CUMMINSIND's 2.2% Dividend Yield

Dividend paying stocks like Cummins India Limited (NSE:CUMMINSIND) 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 slim 2.2% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Cummins India could have potential. That said, the recent jump in the share price will make Cummins India's dividend yield look smaller, even though the company prospects could be improving. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Cummins India paid out 33% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Cummins India paid out 287% 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. Cummins India paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Cummins India's ability to maintain its dividend.

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

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

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. Cummins India has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 ₹8.6 in 2011, compared to ₹14.0 last year. Dividends per share have grown at approximately 5.0% per year over this time. Cummins India's dividend payments have fluctuated, so it hasn't grown 5.0% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

A reasonable rate of dividend growth is good to see, but we're wary that the dividend history is not as solid as we'd like, having been cut at least once.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Over the past five years, it looks as though Cummins India's EPS have declined at around 5.2% a year. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

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. 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 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, Cummins India has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

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. Case in point: We've spotted 3 warning signs for Cummins India (of which 1 shouldn't be ignored!) you should know about.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

If you decide to trade Cummins India, 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.