Dividend paying stocks like Middlesex Water Company (NASDAQ:MSEX) 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. 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.
While Middlesex Water's 1.5% dividend yield is not the highest, we think its lengthy payment history is quite interesting. 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. 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, Middlesex Water paid out 46% of its profit as dividends. 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.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while Middlesex Water pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.
Is Middlesex Water's Balance Sheet Risky?
As Middlesex Water 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. Middlesex Water has net debt of 4.44 times its EBITDA, which is getting towards the limit of most investors' comfort zones. Judicious use of debt can enhance shareholder returns, but also adds to the risk if something goes awry.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Middlesex Water has EBIT of 5.47 times its interest expense, which we think is adequate.
Remember, you can always get a snapshot of Middlesex Water'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. Middlesex Water has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$0.71 in 2009, compared to US$0.96 last year. Dividends per share have grown at approximately 3.1% per year over this time.
Slow and steady dividend growth might not sound that exciting, but dividends have been stable for ten years, which we think is seriously impressive.
Dividend Growth Potential
Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Middlesex Water has grown its earnings per share at 15% per annum over the past five years. Earnings per share have been growing at a good rate, and the company is paying less than half its earnings as dividends. We generally think this is an attractive combination, as it permits further reinvestment in the business.
To summarise, shareholders should always check that Middlesex Water's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Middlesex Water has a low payout ratio, which we like, although it paid out virtually all of its generated cash. That said, we were glad to see it growing earnings and paying a fairly consistent dividend. Overall we think Middlesex Water is an interesting dividend stock, although it could be better.
Are management backing themselves to deliver performance? Check their shareholdings in Middlesex Water in our latest insider ownership analysis.
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 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.