Key Things To Watch Out For If You Are After Tata Consultancy Services Limited's (NSE:TCS) 1.0% Dividend

Today we'll take a closer look at Tata Consultancy Services Limited (NSE:TCS) 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 your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

A 1.0% yield is nothing to get excited about, but investors probably think the long payment history suggests Tata Consultancy Services has some staying power. 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 Tata Consultancy Services!

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Tata Consultancy Services paid out 35% of its profit as dividends, over the trailing twelve month period. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Tata Consultancy Services paid out 97% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. While Tata Consultancy Services' dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Tata Consultancy Services to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

With a strong net cash balance, Tata Consultancy Services investors may not have much to worry about in the near term from a dividend perspective.

Remember, you can always get a snapshot of Tata Consultancy Services' 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. For the purpose of this article, we only scrutinise the last decade of Tata Consultancy Services' dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past 10-year period, the first annual payment was ₹5.0 in 2011, compared to ₹33.0 last year. Dividends per share have grown at approximately 21% per year over this time.

With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Tata Consultancy Services has grown its earnings per share at 8.6% per annum over the past five years. It's good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term - assuming earnings can be maintained, of course.

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. Tata Consultancy Services has a low payout ratio, which we like, although it paid out virtually all of its generated cash. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. Tata Consultancy Services has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've picked out 1 warning sign for Tata Consultancy Services 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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