Should You Buy Shanthi Gears Limited (NSE:SHANTIGEAR) For Its Dividend?

Is Shanthi Gears Limited (NSE:SHANTIGEAR) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A 1.9% yield is nothing to get excited about, but investors probably think the long payment history suggests Shanthi Gears has some staying power. The company also returned around 8.7% of its market capitalisation to shareholders in the form of stock buybacks over the past year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Shanthi Gears paid out 126% of its profit as dividends, over the trailing twelve month period. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 60% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Shanthi Gears has available to meet other needs. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Shanthi Gears fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

While the above analysis focuses on dividends relative to a company's earnings, we do note Shanthi Gears' 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 Shanthi Gears' latest financial position, by checking our visualisation of its financial health.

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 Shanthi Gears' 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 ₹0.8 in 2010, compared to ₹2.0 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.6% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Shanthi Gears might have put its house in order since then, but we remain cautious.

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. Shanthi Gears has grown its earnings per share at 6.9% per annum over the past five years. Although per-share earnings are growing at a credible rate, virtually all of the income is being paid out as dividends to shareholders. This is okay, but may limit growth in the company's future dividend payments.

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. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. With this information in mind, we think Shanthi Gears may not be an ideal dividend stock.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we've picked out 2 warning signs for Shanthi Gears that investors should take into consideration.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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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