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How Does SDL plc (LON:SDL) Stand Up To These Simple Dividend Safety Checks?

Simply Wall St

Is SDL plc (LON:SDL) 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.

Investors might not know much about SDL's dividend prospects, even though it has been paying dividends for the last eight years and offers a 1.4% yield. While the yield may not look too great, the relatively long payment history is interesting. Some simple research can reduce the risk of buying SDL for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on SDL!

LSE:SDL Historical Dividend Yield, August 18th 2019

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. In the last year, SDL paid out 37% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. SDL paid out a conservative 43% of its free cash flow as dividends last year. 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 SDL'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. The first recorded dividend for SDL, in the last decade, was eight years ago. It's good to see that SDL has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past eight-year period, the first annual payment was UK£0.055 in 2011, compared to UK£0.07 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.1% a year over that time. SDL's dividend payments have fluctuated, so it hasn't grown 3.1% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. It's good to see SDL has been growing its earnings per share at 47% a year over the past 5 years. With high earnings per share growth in recent times and a modest payout ratio, we think this is an attractive combination if earnings can be reinvested to generate further growth.

We'd also point out that SDL issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.

Conclusion

To summarise, shareholders should always check that SDL's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that SDL has low and conservative payout ratios. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. All things considered, SDL looks like a strong prospect. At the right valuation, it could be something special.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 7 SDL analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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.