Dividend paying stocks like Graham Corporation (NYSE:GHM) 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 slim 2.2% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Graham could have potential. Some simple research can reduce the risk of buying Graham for its dividend – read on to learn more.
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. While Graham pays a dividend, it reported a loss over the last year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.
Graham paid out 476% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely.
With a strong net cash balance, Graham investors may not have much to worry about in the near term from a dividend perspective.
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. Graham has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 ten-year period, the first annual payment was US$0.08 in 2009, compared to US$0.44 last year. Dividends per share have grown at approximately 19% per year over this time.
With rapid dividend growth and no notable cuts to the dividend over a lengthy period of time, we think this company has a lot going for it.
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. Over the past five years, it looks as though Graham’s EPS have declined at around 51% a year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.
To summarise, shareholders should always check that Graham’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 a concern to see that the company paid a dividend despite reporting a loss, and the dividend was also not well covered by free cash flow. Second, it has a limited history of earnings per share growth, but at least the dividends have been relatively stable. In this analysis, Graham doesn’t shape up too well as a dividend stock. We’d find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 3 analysts we track are forecasting for the future.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.