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Should Gunnebo AB (publ) (STO:GUNN) Be Part Of Your Dividend Portfolio?

Simply Wall St

Today we'll take a closer look at Gunnebo AB (publ) (STO:GUNN) 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. 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.

Investors might not know much about Gunnebo's dividend prospects, even though it has been paying dividends for the last nine years and offers a 2.0% 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. There are a few simple ways to reduce the risks of buying Gunnebo for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

OM:GUNN Historical Dividend Yield, November 2nd 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. Gunnebo paid out 35% of its profit as dividends, over the trailing twelve month period. 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.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 62% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Gunnebo has available to meet other needs. It's positive to see that Gunnebo'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 Gunnebo's Balance Sheet Risky?

As Gunnebo has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Gunnebo is carrying net debt of 4.09 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 5.77 times its interest expense appears reasonable for Gunnebo, although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of Gunnebo'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. Looking at the last decade of data, we can see that Gunnebo paid its first dividend at least nine years ago. It's good to see that Gunnebo has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. Its most recent annual dividend was kr0.50 per share, effectively flat on its first payment nine years ago.

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 evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Gunnebo's EPS are effectively flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.

Conclusion

To summarise, shareholders should always check that Gunnebo'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 Gunnebo pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. In sum, we find it hard to get excited about Gunnebo from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Now, if you want to look closer, it would be worth checking out our free research on Gunnebo management tenure, salary, and performance.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.