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Is Cabot Microelectronics Corporation (NASDAQ:CCMP) a good dividend stock? How can we tell? 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.
With a 1.5% yield and a four-year payment history, investors probably think Cabot Microelectronics 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. The company also bought back stock during the year, equivalent to approximately 0.7% of the company's market capitalisation at the time. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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. 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. Looking at the data, we can see that 35% of Cabot Microelectronics's profits were paid out as dividends in the last 12 months. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Cabot Microelectronics's cash payout ratio in the last year was 34%, which suggests dividends were well covered by cash generated by the business. It's positive to see that Cabot Microelectronics'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 Cabot Microelectronics's Balance Sheet Risky?
As Cabot Microelectronics has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Cabot Microelectronics has net debt of 3.04 times 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 12.51 times its interest expense, Cabot Microelectronics's interest cover is quite strong - more than enough to cover the interest expense.
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. Looking at the data, we can see that Cabot Microelectronics has been paying a dividend for the past four years. 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 four-year period, the first annual payment was US$0.72 in 2015, compared to US$1.68 last year. Dividends per share have grown at approximately 24% per year over this 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
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. It's good to see Cabot Microelectronics has been growing its earnings per share at 15% a year over the past 5 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.
To summarise, shareholders should always check that Cabot Microelectronics's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Cabot Microelectronics is paying out a low percentage of its earnings and cash flow. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. Cabot Microelectronics performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 5 Cabot Microelectronics analysts we track are forecasting continued growth with our free report on 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 email@example.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.