Are You An Income Investor? Don't Miss Out On DCM Shriram Limited (NSE:DCMSHRIRAM)

Today we'll take a closer look at DCM Shriram Limited (NSE:DCMSHRIRAM) 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. 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.

A 2.1% yield is nothing to get excited about, but investors probably think the long payment history suggests DCM Shriram has some staying power. Some simple analysis can reduce the risk of holding DCM Shriram 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. DCM Shriram paid out 12% of its profit as dividends, over the trailing twelve month period. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. DCM Shriram paid out 12% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's positive to see that DCM Shriram's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

While the above analysis focuses on dividends relative to a company's earnings, we do note DCM Shriram'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 DCM Shriram'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. For the purpose of this article, we only scrutinise the last decade of DCM Shriram's dividend 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 ₹0.8 in 2011, compared to ₹8.2 last year. This works out to be a compound annual growth rate (CAGR) of approximately 26% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

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

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see DCM Shriram has grown its earnings per share at 28% per annum over the past five years. The company is only paying out a fraction of its earnings as dividends, and in the past been able to use the retained earnings to grow its profits rapidly - an ideal combination.

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. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. 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. All things considered, DCM Shriram looks like a strong prospect. At the right valuation, it could be something special.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. However, there are other things to consider for investors when analysing stock performance. For example, we've picked out 3 warning signs for DCM Shriram that investors should know about before committing capital to this stock.

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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