U.S. Markets open in 3 hrs 2 mins

Are Dividend Investors Getting More Than They Bargained For With Inghams Group Limited's (ASX:ING) Dividend?

Simply Wall St

Today we'll take a closer look at Inghams Group Limited (ASX:ING) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

Inghams Group yields a solid 5.7%, although it has only been paying for three years. It's certainly an attractive yield, but readers are likely curious about its staying power. The company also returned around 13% of its market capitalisation to shareholders in the form of stock buybacks over the past year. 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

ASX:ING Historical Dividend Yield, December 30th 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 58% of Inghams Group's profits were paid out as dividends in the last 12 months. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. With a cash payout ratio of 160%, Inghams Group's dividend payments are poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While Inghams Group'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 Inghams Group to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

We update our data on Inghams Group every 24 hours, so you can always get our latest analysis of its financial health, 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. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past three-year period, the first annual payment was AU$0.052 in 2016, compared to AU$0.20 last year. This works out to be a compound annual growth rate (CAGR) of approximately 55% a year over that time. The dividends haven't grown at precisely 55% every year, but this is a useful way to average out the historical rate of growth.

Inghams Group has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

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? In the last five years, Inghams Group's earnings per share have shrunk at approximately 6.8% per annum. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

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. First, we think Inghams Group has an acceptable payout ratio, although its dividend was not well covered by cashflow. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. Using these criteria, Inghams Group looks quite suboptimal from a dividend investment perspective.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 7 analysts we track are forecasting for the future.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

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.

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. Thank you for reading.