Dividend paying stocks like TransAct Technologies Incorporated (NASDAQ:TACT) 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.
In this case, TransAct Technologies likely looks attractive to dividend investors, given its 3.0% dividend yield and seven-year payment history. We'd agree the yield does look enticing. There are a few simple ways to reduce the risks of buying TransAct Technologies for its dividend, and we'll go through these below.
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. In the last year, TransAct Technologies paid out 49% 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.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. TransAct Technologies paid out 1183% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While TransAct Technologies'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 TransAct Technologies to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.
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 TransAct Technologies has been paying a dividend for the past seven years. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past seven-year period, the first annual payment was US$0.24 in 2012, compared to US$0.36 last year. This works out to be a compound annual growth rate (CAGR) of approximately 6.0% a year over that time.
TransAct Technologies has been growing its dividend at a decent rate, and the payments have been stable despite the short payment history. This is a positive start.
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. TransAct Technologies has grown its earnings per share at 5.2% per annum over the past five years. It's good to see decent earnings growth and a low payout ratio. Companies with these characteristics often display the fastest dividend growth over the long term - assuming earnings can be maintained, of course.
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. TransAct Technologies has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Unfortunately, there hasn't been any earnings growth, and the company's dividend history has been too short for us to evaluate the consistency of the dividend. Ultimately, TransAct Technologies comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.
See if management have their own wealth at stake, by checking insider shareholdings in TransAct Technologies stock.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
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