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Is California Water Service Group (NYSE:CWT) a good dividend stock? How would you know? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 1.5% yield is nothing to get excited about, but investors probably think the long payment history suggests California Water Service Group has some staying power. Some simple research can reduce the risk of buying California Water Service Group for its dividend – read on to learn more.
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. In the last year, California Water Service Group paid out 62% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business – which could be good or bad.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Unfortunately, while California Water Service Group pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it’s not ideal from a dividend perspective. It’s positive to see that California Water Service Group’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.
Is California Water Service Group’s Balance Sheet Risky?
As California Water Service Group has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick way to check a company’s financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company’s total debt. Net interest cover measures the ability to meet interest payments on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. California Water Service Group has net debt of more than 3x its EBITDA, which is getting towards the limit of most investors’ comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company’s net interest expense. With EBIT of 2.61 times its interest expense, California Water Service Group’s interest cover is starting to look a bit thin.
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 California Water Service Group’s dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$0.59 in 2009, compared to US$0.79 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.0% a year over that time.
Dividends have grown relatively slowly, which is not great, but some investors may value the relative consistency of the dividend.
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. Earnings have grown at around 3.7% a year for the past five years, which is better than seeing them shrink! 3.7% per annum is not a particularly high rate of growth, which we find curious. If the company is struggling to grow, perhaps that’s why it elects to pay out more than half of its earnings to shareholders.
To summarise, shareholders should always check that California Water Service Group’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think California Water Service Group has an acceptable payout ratio, although its dividend was not well covered by cashflow. Earnings per share growth has been slow, but we respect a company that maintains a relatively stable dividend. Ultimately, California Water Service Group comes up short on our dividend analysis. It’s not that we think it is a bad company – just that there are likely more appealing dividend prospects out there on this analysis.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for California Water Service Group for free with public analyst estimates for the company.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.