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Why Dividend Hunters Love Hardwoods Distribution Inc. (TSE:HDI)

Simply Wall St

Today we'll take a closer look at Hardwoods Distribution Inc. (TSE:HDI) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

A slim 2.6% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Hardwoods Distribution could have potential. There are a few simple ways to reduce the risks of buying Hardwoods Distribution for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Hardwoods Distribution!

TSX:HDI Historical Dividend Yield, August 3rd 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. In the last year, Hardwoods Distribution paid out 22% of its profit as dividends. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Hardwoods Distribution's cash payout ratio last year was 23%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's positive to see that Hardwoods Distribution's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Is Hardwoods Distribution's Balance Sheet Risky?

As Hardwoods Distribution has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. With net debt of 2.22 times its EBITDA, Hardwoods Distribution has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Net interest cover of 10.02 times its interest expense appears reasonable for Hardwoods Distribution, although we're conscious that even high interest cover doesn't make a company bulletproof.

Remember, you can always get a snapshot of Hardwoods Distribution's latest financial position, by checking our visualisation of its financial health.

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. For the purpose of this article, we only scrutinise the last decade of Hardwoods Distribution's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was CA$0.30 in 2009, compared to CA$0.32 last year. Dividend payments have grown at less than 1% a year over this period.

We're glad to see the dividend has risen, but with a limited rate of growth and fluctuations in the payments, we don't think this is an attractive combination.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? It's good to see Hardwoods Distribution has been growing its earnings per share at 12% a year over the past 5 years. Rapid earnings growth and a low payout ratio suggests this company has been effectively reinvesting in its business. Should that continue, this company could have a bright future.

Conclusion

To summarise, shareholders should always check that Hardwoods Distribution'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 like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. 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. All things considered, Hardwoods Distribution looks like a strong prospect. At the right valuation, it could be something special.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 4 Hardwoods Distribution 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.