Today we'll take a closer look at Ellington Financial Inc. (NYSE:EFC) 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. 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 goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Ellington Financial is a new dividend aristocrat in the making. We'd agree the yield does look enticing. The company also bought back stock equivalent to around 1.8% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
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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. In the last year, Ellington Financial paid out 121% 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.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. The first recorded dividend for Ellington Financial, in the last decade, was nine years ago. It's good to see that Ellington Financial 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 US$3.20 in 2010, compared to US$1.68 last year. The dividend has shrunk at around 6.9% a year during that period. Ellington Financial's dividend has been cut sharply at least once, so it hasn't fallen by -6.9% every year, but this is a decent approximation of the long term change.
Dividend Growth Potential
With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Over the past five years, it looks as though Ellington Financial's EPS have declined at around 16% 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.
To summarise, shareholders should always check that Ellington Financial's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, it's not great to see how much of its earnings are being paid as dividends. 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. With any dividend stock, we look for a sustainable payout ratio, steady dividends, and growing earnings. Ellington Financial has a few too many issues for us to get interested.
Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
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If you spot an error that warrants correction, please contact the editor at email@example.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.