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Is Fresenius Medical Care AG & Co. KGaA (ETR:FME) A Smart Pick For Income Investors?

Simply Wall St

Is Fresenius Medical Care AG & Co. KGaA (ETR:FME) 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.

A 1.6% yield is nothing to get excited about, but investors probably think the long payment history suggests Fresenius Medical Care KGaA has some staying power. The company also returned around 3.3% of its market capitalisation to shareholders in the form of stock buybacks over the past year. Some simple analysis can reduce the risk of holding Fresenius Medical Care KGaA for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Fresenius Medical Care KGaA!

XTRA:FME Historical Dividend Yield May 16th 2020

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. Looking at the data, we can see that 30% of Fresenius Medical Care KGaA's profits were paid out as dividends in the last 12 months. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Fresenius Medical Care KGaA paid out 19% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's positive to see that Fresenius Medical Care KGaA's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Is Fresenius Medical Care KGaA's Balance Sheet Risky?

As Fresenius Medical Care KGaA has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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). With net debt of 2.73 times its EBITDA, Fresenius Medical Care KGaA's debt burden is within a normal range for most listed companies.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Fresenius Medical Care KGaA has EBIT of 5.19 times its interest expense, which we think is adequate.

Remember, you can always get a snapshot of Fresenius Medical Care KGaA's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Fresenius Medical Care KGaA's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was €0.61 in 2010, compared to €1.20 last year. Dividends per share have grown at approximately 7.0% per year over this time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

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. Earnings have grown at around 7.1% a year for the past five years, which is better than seeing them shrink! It's good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term - assuming earnings can be maintained, of course.

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. Firstly, we like that Fresenius Medical Care KGaA has low and conservative payout ratios. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. All things considered, Fresenius Medical Care KGaA looks like a strong prospect. At the right valuation, it could be something special.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. However, there are other things to consider for investors when analysing stock performance. As an example, we've identified 2 warning signs for Fresenius Medical Care KGaA that you should be aware of before investing.

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.