Today we'll take a closer look at Software Service, Inc. (TYO:3733) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
A slim 0.9% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Software Service could have potential. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Click the interactive chart for our full dividend analysis
Payout ratios
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Looking at the data, we can see that 20% of Software Service's profits were paid out as dividends in the last 12 months. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Software Service's cash payout ratio in the last year was 37%, which suggests dividends were well covered by cash generated by the business. 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.
While the above analysis focuses on dividends relative to a company's earnings, we do note Software Service'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 Software Service'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. Software Service has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 JP¥42.0 in 2010, compared to JP¥95.0 last year. This works out to be a compound annual growth rate (CAGR) of approximately 8.5% a year over that time. The dividends haven't grown at precisely 8.5% every year, but this is a useful way to average out the historical rate of growth.
It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Software Service might have put its house in order since then, but we remain cautious.
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. Software Service has grown its earnings per share at 3.6% per annum over the past five years. As we saw above, earnings per share growth has not been strong. However, at least the payout ratio is conservative, and there is plenty of potential to increase this over time.
Conclusion
To summarise, shareholders should always check that Software Service's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Software Service is paying out a low percentage of its earnings and cash flow. Second, earnings growth has been ordinary, and its history of dividend payments is chequered - having cut its dividend at least once in the past. Software Service 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. However, there are other things to consider for investors when analysing stock performance. For instance, we've picked out 1 warning sign for Software Service that investors should take into consideration.
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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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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About TSE:3733
Software Service
Provides electric medical record, hospital total ordering, and other systems.
Flawless balance sheet and undervalued.