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Does NVE Corporation (NASDAQ:NVEC) Have A Place In Your Dividend Stock Portfolio?

Simply Wall St

Dividend paying stocks like NVE Corporation (NASDAQ:NVEC) 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.

With a four-year payment history and a 6.2% yield, many investors probably find NVE intriguing. It sure looks interesting on these metrics - but there's always more to the story . Some simple research can reduce the risk of buying NVE for its dividend - read on to learn more.

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NasdaqCM:NVEC Historical Dividend Yield, August 28th 2019

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. 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. In the last year, NVE paid out 137% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 138%, NVE'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. Cash is slightly more important than profit from a dividend perspective, but given NVE's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

Consider getting our latest analysis on NVE'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 data, we can see that NVE 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 US$4.00 per share, effectively flat on its first payment four years ago.

It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Earnings have grown at around 5.0% a year for the past five years, which is better than seeing them shrink! This level of earnings growth is low, and the company is paying out 137% of its profit. Limited recent earnings growth and a high payout ratio makes it hard for us to envision strong future dividend growth, unless the company should have substantial pricing power or some form of competitive advantage.

Conclusion

To summarise, shareholders should always check that NVE's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're a bit uncomfortable with NVE paying out a high percentage of both its cashflow and earnings. Second, the company has not been able to generate earnings growth, and its history of dividend payments too short for us to thoroughly evaluate the dividend's consistency across an economic cycle. There are a few too many issues for us to get comfortable with NVE from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

See if management have their own wealth at stake, by checking insider shareholdings in NVE stock.

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