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Is First Merchants Corporation (NASDAQ:FRME) An Attractive Dividend Stock?

Simply Wall St

Is First Merchants Corporation (NASDAQ:FRME) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

While First Merchants's 2.6% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple research can reduce the risk of buying First Merchants for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on First Merchants!

NasdaqGS:FRME Historical Dividend Yield, October 30th 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, First Merchants paid out 30% 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. Plus, there is room to increase the payout ratio over time.

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

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. For the purpose of this article, we only scrutinise the last decade of First Merchants's dividend payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was US$0.92 in 2009, compared to US$1.04 last year. Dividends per share have grown at approximately 1.2% per year over this time. The dividends haven't grown at precisely 1.2% every year, but this is a useful way to average out the historical rate of 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

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see First Merchants has grown its earnings per share at 18% per annum over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.

Conclusion

To summarise, shareholders should always check that First Merchants'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 First Merchants has a low and conservative payout ratio. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. First Merchants has a number of positive attributes, but falls short of our ideal dividend company. It may be worth a look at the right price, though.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 8 First Merchants analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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