Could Valeo SA (EPA:FR) 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. 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, Valeo likely looks attractive to dividend investors, given its 4.5% dividend yield and nine-year payment history. We'd agree the yield does look enticing. Some simple research can reduce the risk of buying Valeo for its dividend - read on to learn more.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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. Looking at the data, we can see that 117% of Valeo's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Valeo paid out 83% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. It's good to see that while Valeo's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.
Is Valeo's Balance Sheet Risky?
As Valeo's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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 1.54 times its EBITDA, Valeo 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. Valeo has interest cover of more than 12 times its interest expense, which we think is quite strong.
We update our data on Valeo every 24 hours, so you can always get our latest analysis of its financial health, here.
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. The first recorded dividend for Valeo, in the last decade, was nine years ago. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past nine-year period, the first annual payment was €0.40 in 2011, compared to €1.25 last year. Dividends per share have grown at approximately 13% per year over this time.
The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.
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. Valeo's EPS have fallen by approximately 11% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Valeo's earnings per share, which support the dividend, have been anything but stable.
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. There are a few too many issues for us to get comfortable with Valeo from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.
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.
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 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.
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