What To Know Before Buying Solara Active Pharma Sciences Limited (NSE:SOLARA) For Its Dividend

Today we'll take a closer look at Solara Active Pharma Sciences Limited (NSE:SOLARA) 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. 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.

Some readers mightn't know much about Solara Active Pharma Sciences's 1.1% dividend, as it has only been paying distributions for a year or so. Some simple analysis can reduce the risk of holding Solara Active Pharma Sciences 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Solara Active Pharma Sciences paid out 12% of its profit as dividends, over the trailing twelve month period. We'd say its dividends are thoroughly covered by earnings.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Solara Active Pharma Sciences paid out 8.6% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Is Solara Active Pharma Sciences's Balance Sheet Risky?

As Solara Active Pharma Sciences has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With net debt of 1.67 times its EBITDA, Solara Active Pharma Sciences has an acceptable level of debt.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 2.45 times its interest expense, Solara Active Pharma Sciences's interest cover is starting to look a bit thin.

Remember, you can always get a snapshot of Solara Active Pharma Sciences'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. With a payment history of less than 2 years, we think it's a bit too soon to think about living on the income from its dividend. Its most recent annual dividend was ₹5.00 per share.

It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Solara Active Pharma Sciences has grown its EPS 152% over the past 12 months. It's good to see earnings per share rising, but one year is too short a period to get excited about. Were this trend to continue, we'd be interested. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively. We do note though, one year is too short a time to be drawing strong conclusions about a company's future prospects.

We'd also point out that Solara Active Pharma Sciences issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Firstly, we like that Solara Active Pharma Sciences has low and conservative payout ratios. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Overall we think Solara Active Pharma Sciences scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.

You can also discover whether shareholders are aligned with insider interests by checking our visualisation of insider shareholdings and trades in Solara Active Pharma Sciences stock.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.