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Consider This Before Buying Shakti Pumps (India) Limited (NSE:SHAKTIPUMP) For The 2.4% Dividend

Simply Wall St

Today we'll take a closer look at Shakti Pumps (India) Limited (NSE:SHAKTIPUMP) 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.

A slim 2.4% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Shakti Pumps (India) could have potential. Some simple analysis can reduce the risk of holding Shakti Pumps (India) for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Shakti Pumps (India)!

NSEI:SHAKTIPUMP Historical Dividend Yield, November 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. Shakti Pumps (India) paid out 31% of its profit as dividends, over the trailing twelve month period. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while Shakti Pumps (India) 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.

Is Shakti Pumps (India)'s Balance Sheet Risky?

As Shakti Pumps (India) has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 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. Shakti Pumps (India) has net debt of 2.18 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

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 3.78 times its interest expense, Shakti Pumps (India)'s interest cover is starting to look a bit thin.

Consider getting our latest analysis on Shakti Pumps (India)'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. Shakti Pumps (India) has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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 ₹0.50 in 2009, compared to ₹5.00 last year. Dividends per share have grown at approximately 26% per year over this time. Shakti Pumps (India)'s dividend payments have fluctuated, so it hasn't grown 26% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.

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? Shakti Pumps (India)'s earnings per share have been essentially flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation.

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. It's great to see that Shakti Pumps (India) is paying out a low percentage of its earnings and cash flow. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Shakti Pumps (India) out there.

See if management have their own wealth at stake, by checking insider shareholdings in Shakti Pumps (India) 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.