Key Things To Watch Out For If You Are After Timken India Limited's (NSE:TIMKEN) 3.7% Dividend

Today we'll take a closer look at Timken India Limited (NSE:TIMKEN) 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.

With a nine-year payment history and a 3.7% yield, many investors probably find Timken India intriguing. It sure looks interesting on these metrics - but there's always more to the story. Some simple analysis can reduce the risk of holding Timken India for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Timken India!

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. Looking at the data, we can see that 247% of Timken India's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Timken India paid out 4.6% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's good to see that while Timken India's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

While the above analysis focuses on dividends relative to a company's earnings, we do note Timken 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 Timken 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. The first recorded dividend for Timken India, in the last decade, was nine years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past nine-year period, the first annual payment was ₹40.0 in 2012, compared to ₹50.0 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.5% a year over that time. Timken India's dividend payments have fluctuated, so it hasn't grown 2.5% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

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? It's good to see Timken India has been growing its earnings per share at 11% a year over the past five years. With a payout ratio of 247%, Timken India is paying out dividends substantially greater than what it earned in profit.

Conclusion

To summarise, shareholders should always check that Timken India's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. In sum, we find it hard to get excited about Timken India 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.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. As an example, we've identified 1 warning sign for Timken India that you should be aware of before investing.

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