Dividend paying stocks like Mercor S.A. (WSE:MCR) 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 1.3% yield is nothing to get excited about, but investors probably think the long payment history suggests Mercor 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.
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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Mercor paid out 13% of its profit as dividends, over the trailing twelve month period. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Mercor's cash payout ratio last year was 13%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. 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.
Remember, you can always get a snapshot of Mercor's latest financial position, by checking our visualisation of its financial health.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Mercor's dividend 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 zł0.5 in 2011, compared to zł0.3 last year. The dividend has shrunk at around 6.7% a year during that period. Mercor's dividend has been cut sharply at least once, so it hasn't fallen by 6.7% every year, but this is a decent approximation of the long term change.
When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.
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. It's good to see Mercor has been growing its earnings per share at 47% a year over the past five years. The company is only paying out a fraction of its earnings as dividends, and in the past been able to use the retained earnings to grow its profits rapidly - an ideal combination.
To summarise, shareholders should always check that Mercor's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Mercor has low and conservative payout ratios. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. Mercor performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.
Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. 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 2 warning signs for Mercor 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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