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Does EDAG Engineering Group AG (ETR:ED4) Have A Place In Your Dividend Stock Portfolio?

Simply Wall St

Dividend paying stocks like EDAG Engineering Group AG (ETR:ED4) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

With a four-year payment history and a 8.6% yield, many investors probably find EDAG Engineering Group intriguing. We'd agree the yield does look enticing. Some simple analysis can reduce the risk of holding EDAG Engineering Group for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

XTRA:ED4 Historical Dividend Yield, March 14th 2020

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. EDAG Engineering Group paid out 120% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. EDAG Engineering Group paid out 268% of its free cash flow last year, suggesting the dividend is 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. Cash is slightly more important than profit from a dividend perspective, but given EDAG Engineering Group's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Is EDAG Engineering Group's Balance Sheet Risky?

As EDAG Engineering Group's dividend was not well covered by earnings, 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 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. With net debt of 2.98 times its EBITDA, EDAG Engineering Group has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. EDAG Engineering Group has EBIT of 7.72 times its interest expense, which we think is adequate.

We update our data on EDAG Engineering Group every 24 hours, so you can always get our latest analysis of its financial health, here.

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. EDAG Engineering Group has been paying a dividend for the past four years. The dividend has not fluctuated much, but with a relatively short payment history, we can't be sure this is sustainable across a full market cycle. Its most recent annual dividend was €0.75 per share, effectively flat on its first payment four years ago.

Modest dividend growth is good to see, especially with the payments being relatively stable. However, the payment history is relatively short and we wouldn't want to rely on this dividend too much.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. EDAG Engineering Group's EPS have fallen by approximately 73% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and EDAG Engineering Group's earnings per share, which support the dividend, have been anything but stable.

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. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. In this analysis, EDAG Engineering Group doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.

Market movements attest to how highly valued a consistent dividend policy is to one to which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 3 warning signs for EDAG Engineering Group that investors need to be conscious of moving forward.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.