Is Muto Seiko Co. (TYO:7927) An Attractive Dividend Stock?

Dividend paying stocks like Muto Seiko Co. (TYO:7927) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. 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 2.4% yield is nothing to get excited about, but investors probably think the long payment history suggests Muto Seiko has some staying power. There are a few simple ways to reduce the risks of buying Muto Seiko for its dividend, and we'll go through these below.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Muto Seiko paid out 73% 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.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Muto Seiko's cash payout ratio last year was 7.2%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Muto Seiko's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

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

Consider getting our latest analysis on Muto Seiko's financial position here.

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 Muto Seiko's 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¥27.5 in 2011, compared to JP¥16.0 last year. This works out to be a decline of approximately 5.3% per year over that time. Muto Seiko's dividend hasn't shrunk linearly at 5.3% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying Muto Seiko for its dividend, given that payments have shrunk over the past 10 years.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Muto Seiko has grown its earnings per share at 46% per annum over the past five years. With recent, rapid earnings per share growth and a payout ratio of 73%, this business looks like an interesting prospect if earnings are reinvested effectively.

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. First, we think Muto Seiko has an acceptable payout ratio and its dividend is well covered by cashflow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Muto Seiko 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. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. As an example, we've identified 4 warning signs for Muto Seiko 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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