U.S. Markets open in 4 hrs 29 mins

Should You Buy IPH Limited (ASX:IPH) For Its 2.8% Dividend?

Simply Wall St

Is IPH Limited (ASX:IPH) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

With a 2.8% yield and a four-year payment history, investors probably think IPH looks like a reliable dividend stock. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on IPH!

ASX:IPH Historical Dividend Yield, August 9th 2019

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. 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. IPH paid out 100% of its profit as dividends, over the trailing twelve month period. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable - still, we think it is a concern.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. The company paid out 83% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and IPH fortunately did generate enough cash to fund its dividend. 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.

Is IPH's Balance Sheet Risky?

As IPH's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) 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). IPH has net debt of 0.044 times its EBITDA, which is generally an okay level of debt for most companies.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 35.56 times its interest expense, IPH's interest cover is quite strong - more than enough to cover the interest expense.

We update our data on IPH 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. IPH has been paying a dividend for the past four years. The dividend has not fluctuated much, but with a relatively short payment history, we can't be sure this is sustainable across a full market cycle. During the past four-year period, the first annual payment was AU$0.07 in 2015, compared to AU$0.23 last year. Dividends per share have grown at approximately 35% per year over this time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Earnings have grown at around 5.6% a year for the past three years, which is better than seeing them shrink! Although per-share earnings are growing at a credible rate, virtually all of the income is being paid out as dividends to shareholders. This is okay, but may limit growth in the company's future dividend payments.

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. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, the company has not been able to generate earnings growth, and its history of dividend payments too short for us to thoroughly evaluate the dividend's consistency across an economic cycle. With this information in mind, we think IPH may not be an ideal dividend stock.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 4 IPH analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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 editorial-team@simplywallst.com. 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.