Is Ambika Cotton Mills Limited (NSE:AMBIKCO) A Smart Pick For Income Investors?

Dividend paying stocks like Ambika Cotton Mills Limited (NSE:AMBIKCO) 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. 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 slim 1.6% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Ambika Cotton Mills could have potential. That said, the recent jump in the share price will make Ambika Cotton Mills's dividend yield look smaller, even though the company prospects could be improving. There are a few simple ways to reduce the risks of buying Ambika Cotton Mills for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Ambika Cotton Mills!

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. In the last year, Ambika Cotton Mills paid out 17% of its profit as dividends. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.

Consider getting our latest analysis on Ambika Cotton Mills' financial position here.

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. Ambika Cotton Mills 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 ₹3.0 in 2011, compared to ₹15.0 last year. Dividends per share have grown at approximately 17% per year over this time. Ambika Cotton Mills' dividend payments have fluctuated, so it hasn't grown 17% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

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? Ambika Cotton Mills' earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. As we saw above, earnings per share growth has not been strong. On the plus side, the dividend payout ratio is low and dividends could grow faster than earnings, if the company decides to increase its payout ratio.

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 glad to see Ambika Cotton Mills has a low payout ratio, as this suggests earnings are being reinvested in the business. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. Ambika Cotton Mills might not be a bad business, but it doesn't show all of the characteristics we look for in a dividend stock.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. To that end, Ambika Cotton Mills has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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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