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Would Reach plc (LON:RCH) Be Valuable To Income Investors?

Simply Wall St

Is Reach plc (LON:RCH) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

In this case, Reach likely looks attractive to dividend investors, given its 6.5% dividend yield and five-year payment history. We'd agree the yield does look enticing. The company also bought back stock during the year, equivalent to approximately 0.6% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying Reach for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

LSE:RCH Historical Dividend Yield, November 23rd 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Reach paid out 46% of its profit as dividends, over the trailing twelve month period. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Reach's cash payout ratio last year was 22%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Reach'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 Reach's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the data, we can see that Reach has been paying a dividend for the past five years. During the past five-year period, the first annual payment was UK£0.03 in 2014, compared to UK£0.061 last year. This works out to be a compound annual growth rate (CAGR) of approximately 15% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.

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? Over the past five years, it looks as though Reach's EPS have declined at around 24% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Reach's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that Reach's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Reach has low and conservative payout ratios. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Reach out there.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 3 analysts we track are forecasting for the future.

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.