U.S. Markets closed

Is K3 Capital Group PLC (LON:K3C) At Risk Of Cutting Its Dividend?

Simply Wall St

Dividend paying stocks like K3 Capital Group PLC (LON:K3C) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

K3 Capital Group pays a 3.3% dividend yield, and has been paying dividends for the past two years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. Remember though, due to the recent spike in its share price, K3 Capital Group's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

Explore this interactive chart for our latest analysis on K3 Capital Group!

AIM:K3C Historical Dividend Yield, December 25th 2019

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 81% of K3 Capital Group'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. K3 Capital Group paid out 154% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While K3 Capital Group's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were K3 Capital Group to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

While the above analysis focuses on dividends relative to a company's earnings, we do note K3 Capital Group's strong net cash position, which will let it pay larger dividends for a time, should it choose.

Remember, you can always get a snapshot of K3 Capital Group'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. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past two-year period, the first annual payment was UK£0.044 in 2017, compared to UK£0.076 last year. This works out to be a compound annual growth rate (CAGR) of approximately 31% a year over that time. K3 Capital Group's dividend payments have fluctuated, so it hasn't grown 31% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. K3 Capital Group's EPS have fallen by approximately 13% per year during the past five years. 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

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. First, we think K3 Capital Group has an acceptable payout ratio, although its dividend was not well covered by cashflow. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. There are a few too many issues for us to get comfortable with K3 Capital Group from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

You can also discover whether shareholders are aligned with insider interests by checking our visualisation of insider shareholdings and trades in K3 Capital Group stock.

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