Would Avertronics Inc. (GTSM:3597) Be Valuable To Income Investors?

Today we'll take a closer look at Avertronics Inc. (GTSM:3597) 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 2.9% yield is nothing to get excited about, but investors probably think the long payment history suggests Avertronics has some staying power. That said, the recent jump in the share price will make Avertronics's dividend yield look smaller, even though the company prospects could be improving. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Avertronics paid out 70% of its profit as dividends. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Avertronics paid out 886% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While Avertronics' dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Avertronics to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Remember, you can always get a snapshot of Avertronics' latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

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. Avertronics has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 NT$0.1 in 2011, compared to NT$0.8 last year. Dividends per share have grown at approximately 21% 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.

Avertronics has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Avertronics has grown its earnings per share at 11% per annum over the past five years. Avertronics' earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.

We'd also point out that Avertronics issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.

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 Avertronics has an acceptable payout ratio, although its dividend was not well covered by cashflow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. In sum, we find it hard to get excited about Avertronics from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

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. To that end, Avertronics has 5 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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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