Dividend paying stocks like Mota-Engil, SGPS, S.A. (ELI:EGL) 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. 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.
A high yield and a long history of paying dividends is an appealing combination for Mota-Engil SGPS. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock equivalent to around 1.0% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Mota-Engil SGPS for its dividend, and we'll go through these below.
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. 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. Mota-Engil SGPS paid out 73% of its profit as dividends, over the trailing twelve month period. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, Mota-Engil SGPS paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is Mota-Engil SGPS's Balance Sheet Risky?
As Mota-Engil SGPS has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With net debt of 4.37 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 1.07 times its interest expense, Mota-Engil SGPS's interest cover is starting to look a bit thin.
Consider getting our latest analysis on Mota-Engil SGPS's financial position 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. Mota-Engil SGPS has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was €0.11 in 2009, compared to €0.074 last year. This works out to be a decline of approximately 3.9% per year over that time. Mota-Engil SGPS's dividend has been cut sharply at least once, so it hasn't fallen by 3.9% every year, but this is a decent approximation of the long term change.
When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.
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. Mota-Engil SGPS's EPS have fallen by approximately 17% per year. 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.
To summarise, shareholders should always check that Mota-Engil SGPS's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. There are a few too many issues for us to get comfortable with Mota-Engil SGPS 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. See if the 3 analysts are forecasting a turnaround in our free collection of analyst estimates here.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.