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Three Things You Should Check Before Buying McPherson's Limited (ASX:MCP) For Its Dividend

Simply Wall St

Is McPherson's Limited (ASX:MCP) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 McPherson's yielding 5.3% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. Remember though, due to the recent spike in its share price, McPherson's's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. Some simple analysis can reduce the risk of holding McPherson's for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

ASX:MCP Historical Dividend Yield, July 26th 2019

Payout ratios

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. Looking at the data, we can see that 77% of McPherson's's profits were paid out as dividends in the last 12 months. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

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

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. McPherson's has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was AU$0.26 in 2009, compared to AU$0.10 last year. The dividend has shrunk at around 9.1% a year during that period. McPherson's's dividend has been cut sharply at least once, so it hasn't fallen by 9.1% every year, but this is a decent approximation of the long term change.

We struggle to make a case for buying McPherson's for its dividend, given that payments have shrunk over the past ten years.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. It's good to see McPherson's has been growing its earnings per share at 48% a year over the past 5 years. A majority of profits are being paid out as dividends, which raises the question of what happens to the current dividend if earnings decline. However, the rapid growth in earnings may indicate that is less of a risk.

Conclusion

To summarise, shareholders should always check that McPherson's'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 McPherson's has an acceptable payout ratio and its dividend is well covered by cashflow. 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. McPherson's has a number of positive attributes, but it falls slightly short of our (admittedly high) standards. Were there evidence of a strong moat or an attractive valuation, it could still be well worth a look.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 4 McPherson's analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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 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.