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Do Investors Have Good Reason To Be Wary Of Argan, Inc.'s (NYSE:AGX) 2.6% Dividend Yield?

Simply Wall St

Dividend paying stocks like Argan, Inc. (NYSE:AGX) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a 2.6% yield and a seven-year payment history, investors probably think Argan looks like a reliable dividend stock. 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 Argan for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Argan!

NYSE:AGX Historical Dividend Yield, August 7th 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. 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 90% of Argan's profits were paid out as dividends in the last 12 months. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while Argan pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

With a strong net cash balance, Argan investors may not have much to worry about in the near term from a dividend perspective.

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

Dividend Volatility

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 data, we can see that Argan has been paying a dividend for the past seven years. Its dividend has not fluctuated much that time, which we like, but we're conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past seven-year period, the first annual payment was US$0.60 in 2012, compared to US$1.00 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.6% a year over that time.

Argan has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Argan's EPS have fallen by approximately 17% per year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

To summarise, shareholders should always check that Argan's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Unfortunately, there hasn't been any earnings growth, and the company's dividend history has been too short for us to evaluate the consistency of the dividend. In this analysis, Argan 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.

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

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