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Do Investors Have Good Reason To Be Wary Of TESSCO Technologies Incorporated's (NASDAQ:TESS) 7.7% Dividend Yield?

Simply Wall St

Dividend paying stocks like TESSCO Technologies Incorporated (NASDAQ:TESS) 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. 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.

In this case, TESSCO Technologies likely looks attractive to investors, given its 7.7% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. Remember though, given the recent drop in its share price, TESSCO Technologies's yield will look higher, even though the market may now be expecting a decline in its long-term prospects. 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 TESSCO Technologies!

NasdaqGS:TESS Historical Dividend Yield, January 16th 2020

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, TESSCO Technologies paid out 935% 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.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while TESSCO Technologies 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.

Is TESSCO Technologies's Balance Sheet Risky?

As TESSCO Technologies'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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 5.78 times its EBITDA, TESSCO Technologies could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 2.28 times its interest expense is starting to become a concern for TESSCO Technologies, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.

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

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. For the purpose of this article, we only scrutinise the last decade of TESSCO Technologies's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$0.27 in 2010, compared to US$0.80 last year. This works out to be a compound annual growth rate (CAGR) of approximately 12% a year over that time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. TESSCO Technologies's earnings per share have shrunk at 47% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and TESSCO Technologies's earnings per share, which support the dividend, have been anything but stable.

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 TESSCO Technologies paying out a high percentage of both its cashflow and earnings. Second, earnings per share have actually shrunk, but at least the dividends have been relatively stable. In this analysis, TESSCO Technologies 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.

Are management backing themselves to deliver performance? Check their shareholdings in TESSCO Technologies in our latest insider ownership analysis.

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 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.

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. Thank you for reading.