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Know This Before Buying Harvey Norman Holdings Limited (ASX:HVN) For Its Dividend

Simply Wall St

Today we'll take a closer look at Harvey Norman Holdings Limited (ASX:HVN) 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. 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, Harvey Norman Holdings likely looks attractive to investors, given its 7.9% 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. 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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ASX:HVN Historical Dividend Yield, November 13th 2019

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Harvey Norman Holdings paid out 95% of its profit as dividends. With a payout ratio this high, we'd say its dividend is not well covered by earnings. This may be fine if earnings are growing, but it might not take much of a downturn for the dividend to come under pressure.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Harvey Norman Holdings paid out 123% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Cash is slightly more important than profit from a dividend perspective, but given Harvey Norman Holdings's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

Consider getting our latest analysis on Harvey Norman Holdings's financial position here.

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 Harvey Norman Holdings's dividend payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was AU$0.12 in 2009, compared to AU$0.33 last year. Dividends per share have grown at approximately 11% per year over this time. The dividends haven't grown at precisely 11% every year, but this is a useful way to average out the historical rate of growth.

Harvey Norman Holdings has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Harvey Norman Holdings has grown its earnings per share at 12% per annum over the past five years. While EPS are growing rapidly, Harvey Norman Holdings paid out a very high 95% of its income as dividends. If earnings continue to grow, this dividend may be sustainable, but we think a payout this high definitely bears watching.

We'd also point out that Harvey Norman Holdings issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

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. Harvey Norman Holdings paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Overall, Harvey Norman Holdings falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 7 analysts we track are forecasting for Harvey Norman Holdings for free with public analyst estimates 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%.

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.