Dividend paying stocks like Ratti S.p.A. (BIT:RAT) 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.
With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Ratti is a new dividend aristocrat in the making. We'd agree the yield does look enticing. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Looking at the data, we can see that 53% of Ratti's profits were paid out as dividends in the last 12 months. 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.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. The company paid out 54% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Ratti has available to meet other needs. It's positive to see that Ratti's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Remember, you can always get a snapshot of Ratti's latest financial position, by checking our visualisation of its financial health.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. Looking at the data, we can see that Ratti has been paying a dividend for the past seven years. The dividend has been quite stable over the past seven years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past seven-year period, the first annual payment was €0.10 in 2012, compared to €0.20 last year. This works out to be a compound annual growth rate (CAGR) of approximately 10% a year over that time.
Ratti has been growing its dividend quite rapidly, which is exciting. However, the short payment history makes us question whether this performance will persist across a full market cycle.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Ratti has grown its earnings per share at 27% per annum over the past five years. With recent, rapid earnings per share growth and a payout ratio of 53%, this business looks like an interesting prospect if earnings are reinvested effectively.
To summarise, shareholders should always check that Ratti's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Ratti is paying out an acceptable percentage of its cashflow and profit. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Ratti out there.
See if management have their own wealth at stake, by checking insider shareholdings in Ratti stock.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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 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. Thank you for reading.