Here's How We Evaluate Magic Software Enterprises Ltd.'s (NASDAQ:MGIC) Dividend

Dividend paying stocks like Magic Software Enterprises Ltd. (NASDAQ:MGIC) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a 2.3% yield and a nine-year payment history, investors probably think Magic Software Enterprises looks like a reliable dividend stock. A 2.3% yield is not inspiring, but the longer payment history has some appeal. Some simple analysis can reduce the risk of holding Magic Software Enterprises for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Magic Software Enterprises!

Payout ratios

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Magic Software Enterprises paid out 79% of its profit as dividends, over the trailing twelve month period. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Magic Software Enterprises' cash payout ratio in the last year was 27%, which suggests dividends were well covered by cash generated by the business. It's positive to see that Magic Software Enterprises' 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.

With a strong net cash balance, Magic Software Enterprises investors may not have much to worry about in the near term from a dividend perspective.

We update our data on Magic Software Enterprises every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the last decade of data, we can see that Magic Software Enterprises paid its first dividend at least nine years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past nine-year period, the first annual payment was US$0.2 in 2012, compared to US$0.4 last year. Dividends per share have grown at approximately 7.5% per year over this time. Magic Software Enterprises' dividend payments have fluctuated, so it hasn't grown 7.5% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Dividends have grown at a reasonable rate, but with at least one substantial cut in the payments, we're not certain this dividend stock would be ideal for someone intending to live on the income.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Magic Software Enterprises has grown its earnings per share at 5.9% per annum over the past five years. EPS have been growing at a reasonable rate, although with most of the profits being paid out to shareholders, we question if the company will be able to keep growing its dividends in the future.

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. Magic Software Enterprises' payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Magic Software Enterprises out there.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. As an example, we've identified 1 warning sign for Magic Software Enterprises that you should be aware of before investing.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

If you decide to trade Magic Software Enterprises, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.