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How Does Bodycote plc (LON:BOY) Fare As A Dividend Stock?

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Is Bodycote plc (LON:BOY) a good dividend stock? How can we tell? 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.

In this case, Bodycote likely looks attractive to investors, given its 4.2% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock during the year, equivalent to approximately 0.9% of the company's market capitalisation at the time. Remember though, due to the recent spike in its share price, Bodycote's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. There are a few simple ways to reduce the risks of buying Bodycote for its dividend, and we'll go through these below.

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LSE:BOY Historical Dividend Yield, January 8th 2020
LSE:BOY Historical Dividend Yield, January 8th 2020

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, 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. Bodycote paid out 37% 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. 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. Bodycote's cash payout ratio in the last year was 45%, which suggests dividends were well covered by cash generated by 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.

Consider getting our latest analysis on Bodycote'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. For the purpose of this article, we only scrutinise the last decade of Bodycote's dividend payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was UK£0.10 in 2010, compared to UK£0.39 last year. This works out to be a compound annual growth rate (CAGR) of approximately 14% a year over that time. Bodycote's dividend payments have fluctuated, so it hasn't grown 14% 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 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. Earnings have grown at around 6.4% a year for the past five years, which is better than seeing them shrink! It's good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term - assuming earnings can be maintained, of course.

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. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. Overall we think Bodycote 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 Bodycote analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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