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Are Dividend Investors Getting More Than They Bargained For With Arcadis NV's (AMS:ARCAD) Dividend?

Simply Wall St

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Dividend paying stocks like Arcadis NV (AMS:ARCAD) 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 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 Arcadis's dividend prospects, even though it has been paying dividends for the last nine years and offers a 2.9% yield. A 2.9% yield is not inspiring, but the longer payment history has some appeal. The company also bought back stock during the year, equivalent to approximately 0.5% of the company's market capitalisation at the time. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

ENXTAM:ARCAD Historical Dividend Yield, June 11th 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. While Arcadis pays a dividend, it reported a loss over the last year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

Arcadis paid out 9.8% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable.

Is Arcadis's Balance Sheet Risky?

Given Arcadis is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. 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 measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). With net debt of 1.76 times its earnings before interest, tax, depreciation and amortisation (EBITDA), Arcadis has an acceptable level of debt.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 6.21 times its interest expense appears reasonable for Arcadis, although we're conscious that even high interest cover doesn't make a company bulletproof.

Consider getting our latest analysis on Arcadis's financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the last decade of data, we can see that Arcadis paid its first dividend at least nine years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once by more than 20%, and we're cautious about the consistency of its dividend across a full economic cycle. During the past nine-year period, the first annual payment was €0.45 in 2010, compared to €0.47 last year. Its dividends have grown at less than 1% per annum over this time frame.

Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. In the last five years, Arcadis's earnings per share have shrunk at approximately 23% per annum. 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. We're not keen on the fact that Arcadis paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Earnings per share are down, and Arcadis's dividend has been cut at least once in the past, which is disappointing. With this information in mind, we think Arcadis may not be an ideal dividend stock.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 4 analysts are forecasting a turnaround in our free collection of analyst estimates here.

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.