Dividend paying stocks like Kothari Petrochemicals Limited (NSE:KOTHARIPET) tend to be popular with investors, and for good reason – some research shows that 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.
In this case, Kothari Petrochemicals likely looks attractive to dividend investors, given its 4.1% dividend yield and seven-year payment history. It sure looks interesting on these metrics – but there’s always more to the story . When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.Explore this interactive chart for our latest analysis on Kothari Petrochemicals!
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to be form a view on if a company’s dividend is sustainable, relative to its net profit after tax. Kothari Petrochemicals paid out 56% of its profit as dividends, over the trailing twelve month period. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Last year, Kothari Petrochemicals paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
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. Looking at the data, we can see that Kothari Petrochemicals has been paying a dividend for the past seven years. Although it has been paying a dividend for several years now, the dividend has been cut at least once by more than 20%, and we’re cautious about the consistency of its dividend across a full economic cycle. During the past seven-year period, the first annual payment was ₹0.50 in 2012, compared to ₹0.75 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.0% a year over that time. The dividends haven’t grown at precisely 6.0% 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 substantial fluctuations 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? Kothari Petrochemicals has grown its earnings per share at 8.6% per annum over the past five years. Earnings per share are growing at an acceptable rate, although the company is paying out more than half of its profits, which we think could constrain its ability to reinvest in its business.
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 think Kothari Petrochemicals has an acceptable payout ratio, although its dividend was not well covered by cashflow. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. Overall, Kothari Petrochemicals falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
Are management backing themselves to deliver performance? Check their shareholdings in Kothari Petrochemicals in our latest insider ownership analysis.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.