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Is Colefax Group PLC (LON:CFX) A Smart Choice For Dividend Investors?

Simply Wall St

Dividend paying stocks like Colefax Group PLC (LON:CFX) 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.

A slim 1.3% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Colefax Group could have potential. The company also bought back stock during the year, equivalent to approximately 12% 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.

Click the interactive chart for our full dividend analysis

AIM:CFX Historical Dividend Yield, October 19th 2019

Payout ratios

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, Colefax Group paid out 13% of its profit as dividends. We'd say its dividends are thoroughly covered by earnings.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Colefax Group paid out 10% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

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

Consider getting our latest analysis on Colefax Group's financial position 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. For the purpose of this article, we only scrutinise the last decade of Colefax Group's dividend payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was UK£0.042 in 2009, compared to UK£0.052 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.2% a year over that time. Colefax Group's dividend payments have fluctuated, so it hasn't grown 2.2% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

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? Earnings have grown at around 7.1% a year for the past five years, which is better than seeing them shrink! With a decent amount of growth and a low payout ratio, we think this bodes well for Colefax Group's prospects of growing its dividend payments in the future.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. It's great to see that Colefax Group is paying out a low percentage of its earnings and cash flow. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. Overall we think Colefax Group is an interesting dividend stock, although it could be better.

See if management have their own wealth at stake, by checking insider shareholdings in Colefax Group stock.

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 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.