Dividend paying stocks like Vector Limited (NZSE:VCT) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
In this case, Vector likely looks attractive to investors, given its 3.9% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. There are a few simple ways to reduce the risks of buying Vector for its dividend, and we'll go through these below.
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. In the last year, Vector paid out 141% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, Vector paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
We update our data on Vector every 24 hours, so you can always get our latest analysis of its financial health, here.
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 Vector's dividend payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past 10-year period, the first annual payment was NZ$0.1 in 2011, compared to NZ$0.2 last year. Dividends per share have grown at approximately 1.7% per year over this time.
While the consistency in the dividend payments is impressive, we think the relatively slow rate of growth is unappealing.
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. Vector has grown its earnings per share at 4.9% per annum over the past five years. This level of earnings growth is low, and the company is paying out 141% of its profit. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.
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. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. Overall, Vector falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
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 picked out 2 warning signs for Vector that investors should know about before committing capital to this stock.
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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