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Should GR Engineering Services Limited (ASX:GNG) Be Part Of Your Income Portfolio?

Simply Wall St

Is GR Engineering Services Limited (ASX:GNG) 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.

In this case, GR Engineering Services likely looks attractive to dividend investors, given its 4.3% dividend yield and eight-year payment history. We'd agree the yield does look enticing. Some simple analysis can reduce the risk of holding GR Engineering Services for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

ASX:GNG Historical Dividend Yield, February 5th 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 141% of GR Engineering Services's profits were paid out as dividends in the last 12 months. 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. GR Engineering Services paid out 58% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's good to see that while GR Engineering Services's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

While the above analysis focuses on dividends relative to a company's earnings, we do note GR Engineering Services's strong net cash position, which will let it pay larger dividends for a time, should it choose.

Remember, you can always get a snapshot of GR Engineering Services'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. Looking at the last decade of data, we can see that GR Engineering Services paid its first dividend at least eight years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past eight-year period, the first annual payment was AU$0.15 in 2012, compared to AU$0.04 last year. The dividend has fallen 73% over that period.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. GR Engineering Services's EPS have fallen by approximately 15% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and GR Engineering Services's earnings per share, which support the dividend, have been anything but stable.

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. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Earnings per share are down, and GR Engineering Services's dividend has been cut at least once in the past, which is disappointing. In this analysis, GR Engineering Services doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.

See if management have their own wealth at stake, by checking insider shareholdings in GR Engineering Services stock.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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.