Today we'll take a closer look at Cogent Communications Holdings, Inc. (NASDAQ:CCOI) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Cogent Communications Holdings is a new dividend aristocrat in the making. It sure looks interesting on these metrics - but there's always more to the story . There are a few simple ways to reduce the risks of buying Cogent Communications Holdings for its dividend, and we'll go through these below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 289% of Cogent Communications Holdings's profits were paid out as dividends in the last 12 months. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Cogent Communications Holdings paid out 115% of its free cash flow last year, which we think is concerning if cash flows do not improve. Cash is slightly more important than profit from a dividend perspective, but given Cogent Communications Holdings's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.
Is Cogent Communications Holdings's Balance Sheet Risky?
As Cogent Communications Holdings's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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 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. With net debt of 2.18 times its EBITDA, Cogent Communications Holdings'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. Interest cover of 1.95 times its interest expense is starting to become a concern for Cogent Communications Holdings, and be aware that lenders may place additional restrictions on the company as well.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the last decade of data, we can see that Cogent Communications Holdings paid its first dividend at least eight years ago. It's good to see that Cogent Communications Holdings 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 eight-year period, the first annual payment was US$0.40 in 2012, compared to US$2.56 last year. Dividends per share have grown at approximately 26% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.
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? In the last five years, Cogent Communications Holdings's earnings per share have shrunk at approximately 7.8% per annum. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.
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. Cogent Communications Holdings paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. Using these criteria, Cogent Communications Holdings looks quite suboptimal from a dividend investment perspective.
Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 14 analysts we track are forecasting for the future.
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 firstname.lastname@example.org. 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.
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