Dividend paying stocks like TD Power Systems Limited (NSE:TDPOWERSYS) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
Investors might not know much about TD Power Systems’s dividend prospects, even though it has been paying dividends for the last eight years and offers a 1.6% yield. A 1.6% yield is not inspiring, but the longer payment history has some appeal. The company also bought back stock equivalent to around 7.3% of market capitalisation this year. Before you buy any stock for its dividend however, you should always remember Warren Buffett’s two rules: 1) Don’t lose money, and 2) Remember rule #1. We’ll run through some checks below to help with this.
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. In the last year, TD Power Systems paid out 66% of its profit as dividends. 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.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. TD Power Systems’s cash payout ratio last year was 20%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. 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.
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. Looking at the last decade of data, we can see that TD Power Systems paid its first dividend at least eight years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once by more than 20%, and we’re cautious about the consistency of its dividend across a full economic cycle. Its most recent annual dividend was ₹2.00 per share, effectively flat on its first payment eight years ago.
It’s good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We’re not that enthused by this.
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? TD Power Systems’s EPS have fallen by approximately 15% per year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and TD Power Systems’s earnings per share, which support the dividend, have been anything but stable.
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 TD Power Systems has an acceptable payout ratio and its dividend is well covered by cashflow. Unfortunately, the company has not been able to generate earnings per share growth, and cut its dividend at least once in the past. In sum, we find it hard to get excited about TD Power Systems from a dividend perspective. It’s not that we think it’s a bad business; just that there are other companies that perform better on these criteria.
Are management backing themselves to deliver performance? Check their shareholdings in TD Power Systems in our latest insider ownership analysis.
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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