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Consider This Before Buying PriceSmart, Inc. (NASDAQ:PSMT) For The 1.4% Dividend

Simply Wall St

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Today we'll take a closer look at PriceSmart, Inc. (NASDAQ:PSMT) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

Investors might not know much about PriceSmart's dividend prospects, even though it has been paying dividends for the last nine years and offers a 1.4% yield. While the yield may not look too great, the relatively long payment history is interesting. Some simple analysis can reduce the risk of holding PriceSmart for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

NasdaqGS:PSMT Historical Dividend Yield, May 31st 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. 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. PriceSmart paid out 28% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. PriceSmart paid out 96% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. While PriceSmart's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were PriceSmart to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Consider getting our latest analysis on PriceSmart'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. Looking at the last decade of data, we can see that PriceSmart paid its first dividend at least nine years ago. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past nine-year period, the first annual payment was US$0.50 in 2010, compared to US$0.70 last year. Dividends per share have grown at approximately 3.8% per year over this time.

It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.

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. Over the past five years, it looks as though PriceSmart's EPS have declined at around 2.1% a year. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

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. Firstly, the company has a conservative payout ratio, although we'd note that its cashflow in the past year was substantially lower than its reported profit. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. Overall, PriceSmart falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

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

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.