Dividend paying stocks like Oil and Natural Gas Corporation Limited (NSE:ONGC) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A high yield and a long history of paying dividends is an appealing combination for Oil and Natural Gas. 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 Oil and Natural Gas's dividend yield look smaller, even though the company prospects could be improving. Some simple research can reduce the risk of buying Oil and Natural Gas for its dividend - read on to learn more.
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. 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. Looking at the data, we can see that 194% of Oil and Natural Gas' 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.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Oil and Natural Gas paid out 63% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Oil and Natural Gas 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.
We update our data on Oil and Natural Gas every 24 hours, so you can always get our latest analysis of its financial health, here.
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 Oil and Natural Gas' dividend payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was ₹5.5 in 2011, compared to ₹5.0 last year. Dividend payments have shrunk at a rate of less than 1% per annum over this time frame.
A shrinking dividend over a 10-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.
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. Over the past five years, it looks as though Oil and Natural Gas' EPS have declined at around 24% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Oil and Natural Gas' earnings per share, which support the dividend, have been anything but stable.
To summarise, shareholders should always check that Oil and Natural Gas' 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. Earnings per share are down, and Oil and Natural Gas' dividend has been cut at least once in the past, which is disappointing. Using these criteria, Oil and Natural Gas looks quite suboptimal from a dividend investment perspective.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. However, there are other things to consider for investors when analysing stock performance. As an example, we've identified 4 warning signs for Oil and Natural Gas that you should be aware of before investing.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
If you’re looking to trade Oil and Natural Gas, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
Valuation is complex, but we're helping make it simple.
Find out whether Oil and Natural Gas is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.