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Tread With Caution Around Euromoney Institutional Investor PLC's (LON:ERM) 2.5% Dividend Yield

Simply Wall St

Dividend paying stocks like Euromoney Institutional Investor PLC (LON:ERM) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

A slim 2.5% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Euromoney Institutional Investor could have potential. There are a few simple ways to reduce the risks of buying Euromoney Institutional Investor for its dividend, and we'll go through these below.

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LSE:ERM Historical Dividend Yield, December 21st 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. Looking at the data, we can see that 179% of Euromoney Institutional Investor's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 81% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Euromoney Institutional Investor fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

With a strong net cash balance, Euromoney Institutional Investor investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on Euromoney Institutional Investor's financial position 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. Euromoney Institutional Investor has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was UK£0.14 in 2009, compared to UK£0.33 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.0% a year over that time.

Businesses that can grow their dividends at a decent rate and maintain a stable payout can generate substantial wealth for shareholders over the long term.

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. Over the past five years, it looks as though Euromoney Institutional Investor's EPS have declined at around 21% a year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We're a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Moreover, earnings have been shrinking. While the dividends have been fairly steady, we'd wonder for how much longer this will be sustainable if earnings continue to decline. In summary, Euromoney Institutional Investor has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives 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. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.

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.

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