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Tread With Caution Around Lovisa Holdings Limited's (ASX:LOV) 2.7% Dividend Yield

Simply Wall St

Could Lovisa Holdings Limited (ASX:LOV) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

Investors might not know much about Lovisa Holdings's dividend prospects, even though it has been paying dividends for the last four years and offers a 2.7% yield. While the yield may not look too great, the relatively long payment history is interesting. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

ASX:LOV Historical Dividend Yield, December 30th 2019

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. 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 94% of Lovisa Holdings's profits were paid out as dividends in the last 12 months. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable - still, we think it is a concern.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Lovisa Holdings paid out 153% 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. As Lovisa Holdings's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

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

Consider getting our latest analysis on Lovisa Holdings'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. Looking at the data, we can see that Lovisa Holdings has been paying a dividend for the past four years. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past four-year period, the first annual payment was AU$0.081 in 2015, compared to AU$0.33 last year. This works out to be a compound annual growth rate (CAGR) of approximately 42% a year over that time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Lovisa Holdings has grown its earnings per share at 52% per annum over the past five years. The company has been growing its EPS at a very rapid rate, while paying out virtually all of its income as dividends. While EPS could grow fast enough to make the dividend sustainable, in this type of situation, we'd want to pay extra attention to any fragilities in the company's balance sheet.

Conclusion

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. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. In summary, Lovisa Holdings has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 5 analysts we track are forecasting for Lovisa Holdings 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%.

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.

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. Thank you for reading.