The Attractive Combination That Could Earn McGrath RentCorp (NASDAQ:MGRC) A Place In Your Dividend Portfolio

Dividend paying stocks like McGrath RentCorp (NASDAQ:MGRC) 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.

A slim 2.4% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, McGrath RentCorp could have potential. The company also bought back stock during the year, equivalent to approximately 1.1% of the company's market capitalisation at the time. There are a few simple ways to reduce the risks of buying McGrath RentCorp for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on McGrath RentCorp!

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 41% of McGrath RentCorp's profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Plus, there is room to increase 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. McGrath RentCorp's cash payout ratio in the last year was 36%, which suggests dividends were well covered by cash generated by the business. It's positive to see that McGrath RentCorp's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Consider getting our latest analysis on McGrath RentCorp's financial position here.

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. McGrath RentCorp 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 10-year period, the first annual payment was US$0.9 in 2011, compared to US$1.7 last year. Dividends per share have grown at approximately 6.4% per year over this time.

Dividends have grown at a reasonable rate over this period, and without any major cuts in the payment over time, we think this is an attractive combination.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see McGrath RentCorp has grown its earnings per share at 19% per annum over the past five years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.

Conclusion

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. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. McGrath RentCorp has met all of our criteria, including having strong cash flow that covers the dividend. We definitely think it would be worthwhile looking closer.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Taking the debate a bit further, we've identified 1 warning sign for McGrath RentCorp that investors need to be conscious of moving forward.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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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