Are Dividend Investors Getting More Than They Bargained For With Perspecta Inc.'s (NYSE:PRSP) Dividend?

Dividend paying stocks like Perspecta Inc. (NYSE:PRSP) 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.

Some readers mightn't know much about Perspecta's 1.3% dividend, as it has only been paying distributions for the last two years. While it may not look like much, if earnings are growing it could become quite interesting. The company also returned around 1.9% of its market capitalisation to shareholders in the form of stock buybacks over the past year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Although Perspecta pays a dividend, it was loss-making during the past year. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

Perspecta paid out 6.3% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable.

Is Perspecta's Balance Sheet Risky?

Given Perspecta is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 3.41 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.23 times its interest expense is starting to become a concern for Perspecta, and be aware that lenders may place additional restrictions on the company as well.

We update our data on Perspecta 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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was US$0.20 in 2018, compared to US$0.28 last year. This works out to be a compound annual growth rate (CAGR) of approximately 18% a year over that time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Perspecta's earnings per share have shrunk at 59% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Perspecta's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Perspecta's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're not keen on the fact that Perspecta paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Earnings per share are down, and to our mind Perspecta has not been paying a dividend long enough to demonstrate its resilience across economic cycles. In summary, Perspecta has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

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. For example, we've identified 2 warning signs for Perspecta (1 shouldn't be ignored!) that you should be aware of before investing.

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. Thank you for reading.