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Factors Income Investors Should Consider Before Adding Diversified Royalty Corp. (TSE:DIV) To Their Portfolio

Simply Wall St

Dividend paying stocks like Diversified Royalty Corp. (TSE:DIV) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a five-year payment history and a 7.3% yield, many investors probably find Diversified Royalty intriguing. It sure looks interesting on these metrics - but there's always more to the story . Some simple analysis can reduce the risk of holding Diversified Royalty for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

TSX:DIV Historical Dividend Yield, December 12th 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. 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. Diversified Royalty paid out 220% 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.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while Diversified Royalty pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

Remember, you can always get a snapshot of Diversified Royalty's latest financial position, by checking our visualisation of its financial health.

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. Diversified Royalty has been paying a dividend for the past five years. During the past five-year period, the first annual payment was CA$0.19 in 2014, compared to CA$0.23 last year. Dividends per share have grown at approximately 4.1% per year over this time.

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

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. It's not great to see that Diversified Royalty's have fallen at approximately 7.4% over the past five years. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

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. Diversified Royalty paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. Second, earnings per share have been in decline, and the dividend history is shorter than we'd like. There are a few too many issues for us to get comfortable with Diversified Royalty from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting 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.