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Should Ricardo plc (LON:RCDO) Be Part Of Your Dividend Portfolio?

Simply Wall St

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Is Ricardo plc (LON:RCDO) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

While Ricardo's 2.8% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on Ricardo!

LSE:RCDO Historical Dividend Yield, July 8th 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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 59% of Ricardo's profits were paid out as dividends in the last 12 months. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio 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. Ricardo paid out 157% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. While Ricardo's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Ricardo to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

We update our data on Ricardo every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

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. For the purpose of this article, we only scrutinise the last decade of Ricardo's dividend payments. During the past ten-year period, the first annual payment was UK£0.11 in 2009, compared to UK£0.20 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.8% a year over that time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if 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. While there may be fluctuations in the past , Ricardo's earnings per share have basically not grown from where they were five years ago. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. Growth of 1.5% is relatively anaemic growth, which we wonder about. If the company is struggling to grow, perhaps that's why it elects to pay out more than half of its earnings to shareholders.

Conclusion

To summarise, shareholders should always check that Ricardo's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Ricardo gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Second, earnings growth has been mediocre, but at least the dividends have been relatively stable. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Ricardo out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for Ricardo 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.