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Is InnoTec TSS AG (FRA:TSS) An Attractive Dividend Stock?

Simply Wall St

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Today we'll take a closer look at InnoTec TSS AG (FRA:TSS) 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.

With a nine-year payment history and a 6.3% yield, many investors probably find InnoTec TSS intriguing. We'd agree the yield does look enticing. Some simple analysis can reduce the risk of holding InnoTec TSS for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on InnoTec TSS!

DB:TSS Historical Dividend Yield, June 12th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Looking at the data, we can see that 85% of InnoTec TSS's profits were paid out as dividends in the last 12 months. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. With a cash payout ratio of 269%, InnoTec TSS's dividend payments are poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. While InnoTec TSS's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were InnoTec TSS to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Consider getting our latest analysis on InnoTec TSS's financial position here.

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 InnoTec TSS paid its first dividend at least nine years ago. It's good to see that InnoTec TSS 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. During the past nine-year period, the first annual payment was €0.20 in 2010, compared to €0.75 last year. Dividends per share have grown at approximately 16% per year over this time. The dividends haven't grown at precisely 16% every year, but this is a useful way to average out the historical rate of growth.

InnoTec TSS has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

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. While there may be fluctuations in the past , InnoTec TSS's earnings per share have basically not grown from where they were five years ago. 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.

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. InnoTec TSS gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Earnings per share are down, and InnoTec TSS's dividend has been cut at least once in the past, which is disappointing. There are a few too many issues for us to get comfortable with InnoTec TSS from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

See if management have their own wealth at stake, by checking insider shareholdings in InnoTec TSS stock.

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.