Is IDFC Limited (NSE:IDFC) A Risky Dividend Stock?

Dividend paying stocks like IDFC Limited (NSE:IDFC) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

In this case, IDFC likely looks attractive to investors, given its 7.3% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. That said, the recent jump in the share price will make IDFC's dividend yield look smaller, even though the company prospects could be improving. Some simple analysis can reduce the risk of holding IDFC for its dividend, and we'll focus on the most important aspects below.

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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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Although it reported a loss over the past 12 months, IDFC currently pays a dividend. When a loss-making financial company pays a dividend, the dividend is not being paid out of profit, which is a concern if the company can't return to operating profitably.

Remember, you can always get a snapshot of IDFC's 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. IDFC has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was ₹1.5 in 2011, compared to ₹3.2 last year. Dividends per share have grown at approximately 7.7% per year over this time. The dividends haven't grown at precisely 7.7% every year, but this is a useful way to average out the historical rate of growth.

Dividends have grown at a reasonable rate, but with at least one substantial cut in the payments, we're not certain this dividend stock would be ideal for someone intending to live on the income.

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? IDFC's EPS have fallen by approximately 22% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and IDFC's earnings per share, which support the dividend, have been anything but stable.

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 it paying a dividend while reporting a loss over the past year. 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. Using these criteria, IDFC looks suboptimal from a dividend investment perspective.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. To that end, IDFC has 3 warning signs (and 1 which makes us a bit uncomfortable) 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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