Tread With Caution Around NKK Switches Co., Ltd.'s (TYO:6943) 2.1% Dividend Yield

Today we'll take a closer look at NKK Switches Co., Ltd. (TYO:6943) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

A slim 2.1% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, NKK Switches could have potential. Some simple research can reduce the risk of buying NKK Switches for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on NKK Switches!

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. Although it reported a loss over the past 12 months, NKK Switches currently pays a dividend. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

NKK Switches paid out 24% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable.

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

Remember, you can always get a snapshot of NKK Switches' 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 NKK Switches' dividend payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was JP¥60.0 in 2011, compared to JP¥80.0 last year. Dividends per share have grown at approximately 2.9% per year over this 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 good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

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. NKK Switches' EPS have fallen by approximately 21% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and NKK Switches' earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that NKK Switches' 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 the company paying a dividend while being loss-making, although at least the dividend was covered by free cash flow. Earnings per share are down, and NKK Switches' dividend has been cut at least once in the past, which is disappointing. In summary, NKK Switches has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

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 identified 3 warning signs for NKK Switches (1 is a bit unpleasant!) that you should be aware of before investing.

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