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Does It Make Sense To Buy Cabot Microelectronics Corporation (NASDAQ:CCMP) For Its Yield?

Simply Wall St

Today we'll take a closer look at Cabot Microelectronics Corporation (NASDAQ:CCMP) 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. 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 Cabot Microelectronics's dividend prospects, even though it has been paying dividends for the last four years and offers a 1.2% yield. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. Some simple analysis can reduce the risk of holding Cabot Microelectronics for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Cabot Microelectronics!

NasdaqGS:CCMP Historical Dividend Yield, December 22nd 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. 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. Cabot Microelectronics paid out 121% 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Cabot Microelectronics paid out a conservative 39% of its free cash flow as dividends last year. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Cabot Microelectronics fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

Is Cabot Microelectronics's Balance Sheet Risky?

As Cabot Microelectronics'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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). Cabot Microelectronics has net debt of 2.31 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Cabot Microelectronics has EBIT of 5.47 times its interest expense, which we think is adequate.

Consider getting our latest analysis on Cabot Microelectronics's financial position 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. Cabot Microelectronics has been paying a dividend for the past four years. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past four-year period, the first annual payment was US$0.72 in 2015, compared to US$1.68 last year. Dividends per share have grown at approximately 24% per year over this time.

Cabot Microelectronics has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.

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. It's not great to see that Cabot Microelectronics's have fallen at approximately 8.3% over the past five years. 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. We're not keen on the fact that Cabot Microelectronics paid out such a high percentage of its income, although its cashflow is in better shape. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. With this information in mind, we think Cabot Microelectronics may not be an ideal dividend stock.

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 3 analysts we track are forecasting for the future.

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.