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Do Investors Have Good Reason To Be Wary Of Ark Restaurants Corp.'s (NASDAQ:ARKR) 5.0% Dividend Yield?

Simply Wall St

Could Ark Restaurants Corp. (NASDAQ:ARKR) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. 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 Ark Restaurants yielding 5.0% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on Ark Restaurants!

NasdaqGM:ARKR Historical Dividend Yield, May 22nd 2019

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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. So we need to be form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Ark Restaurants paid out 118% of its profit as dividends. 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. The company paid out 53% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Ark Restaurants has available to meet other needs. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Ark Restaurants fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is Ark Restaurants's Balance Sheet Risky?

As Ark Restaurants's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures a company's total debt load relative to its earnings (lower = less debt), while net interest cover measures the company's ability to pay the interest on its debt (higher = greater ability to pay interest costs). With net debt of 1.70 times its earnings before interest, tax, depreciation and amortisation (EBITDA), Ark Restaurants has an acceptable level of debt.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of less than 5x its interest expense is starting to become a concern for Ark Restaurants, and be aware that lenders may place additional restrictions on the company as well.

Remember, you can always get a snapshot of Ark Restaurants's latest financial position, by checking our visualisation of its financial health.

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. Ark Restaurants has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. Its most recent annual dividend was US$1.00 per share, effectively flat on its first payment ten years ago.


Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Over the past five years, it looks as though Ark Restaurants's EPS have declined at around 6.4% a year. 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.

Conclusion

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. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Second, earnings per share have actually shrunk, but at least the dividends have been relatively stable. With this information in mind, we think Ark Restaurants may not be an ideal dividend stock.

You can also discover whether shareholders are aligned with insider interests by checking our visualisation of insider shareholdings and trades in Ark Restaurants stock.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.