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Could Rheinmetall AG (FRA:RHM) Have The Makings Of Another Dividend Aristocrat?

Simply Wall St

Is Rheinmetall AG (FRA:RHM) a good dividend stock? How would you know? 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 2.1% yield and a nine-year payment history, investors probably think Rheinmetall looks like a reliable dividend stock. A 2.1% yield is not inspiring, but the longer payment history has some appeal. There are a few simple ways to reduce the risks of buying Rheinmetall for its dividend, and we'll go through these below.

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DB:RHM Historical Dividend Yield, May 24th 2019

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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. Looking at the data, we can see that 29% of Rheinmetall's profits were paid out as dividends in the last 12 months. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Rheinmetall paid out 59% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. 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.

Remember, you can always get a snapshot of Rheinmetall's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

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 last decade of data, we can see that Rheinmetall paid its first dividend at least nine years ago. It's good to see that Rheinmetall has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was €0.30 in 2010, compared to €2.10 last year. This works out to be a compound annual growth rate (CAGR) of approximately 24% a year over that time. The dividends haven't grown at precisely 24% every year, but this is a useful way to average out the historical rate of growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

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? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Rheinmetall has grown its earnings per share at 48% per annum over the past five years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.

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. Firstly, we like that Rheinmetall pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Overall we think Rheinmetall is an interesting dividend stock, although it could be better.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 15 Rheinmetall 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.