Consider This Before Buying Espey Mfg. & Electronics Corp. (NYSEMKT:ESP) For The 5.3% Dividend

Is Espey Mfg. & Electronics Corp. (NYSEMKT:ESP) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

In this case, Espey Mfg. & Electronics likely looks attractive to investors, given its 5.3% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can reduce the risk of holding Espey Mfg. & Electronics for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Espey Mfg. & Electronics!

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Espey Mfg. & Electronics paid out 188% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Espey Mfg. & Electronics paid out 52% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's good to see that while Espey Mfg. & Electronics' dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

With a strong net cash balance, Espey Mfg. & Electronics investors may not have much to worry about in the near term from a dividend perspective.

We update our data on Espey Mfg. & Electronics every 24 hours, so you can always get our latest analysis of its financial health, 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 Espey Mfg. & Electronics' dividend payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was US$1.9 in 2011, compared to US$1.0 last year. The dividend has shrunk at around 6.2% a year during that period. Espey Mfg. & Electronics' dividend has been cut sharply at least once, so it hasn't fallen by 6.2% 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. Over the past five years, it looks as though Espey Mfg. & Electronics' EPS have declined at around 17% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Espey Mfg. & Electronics' earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Espey Mfg. & Electronics' dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Earnings per share are down, and Espey Mfg. & Electronics' dividend has been cut at least once in the past, which is disappointing. There are a few too many issues for us to get comfortable with Espey Mfg. & Electronics from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. To that end, Espey Mfg. & Electronics has 5 warning signs (and 1 which shouldn't be ignored) 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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