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Why McGrath RentCorp (NASDAQ:MGRC) Should Be In Your Dividend Portfolio

Simply Wall St

Could McGrath RentCorp (NASDAQ:MGRC) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

While McGrath RentCorp's 1.9% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple research can reduce the risk of buying McGrath RentCorp for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

NasdaqGS:MGRC Historical Dividend Yield, January 29th 2020

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. McGrath RentCorp paid out 37% of its profit as dividends, over the trailing twelve month period. 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. The company paid out 82% 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 positive to see that McGrath RentCorp'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 McGrath RentCorp's Balance Sheet Risky?

As McGrath RentCorp 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 2.03 times its EBITDA, McGrath RentCorp has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 11.00 times its interest expense appears reasonable for McGrath RentCorp, although we're conscious that even high interest cover doesn't make a company bulletproof.

We update our data on McGrath RentCorp every 24 hours, so you can always get our latest analysis of its financial health, 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. For the purpose of this article, we only scrutinise the last decade of McGrath RentCorp's dividend 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 US$0.88 in 2010, compared to US$1.50 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.5% a year over that time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

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. It's good to see McGrath RentCorp has been growing its earnings per share at 18% a year over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.

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. McGrath RentCorp's dividend payout ratios are within normal bounds, although we note its cash flow is not as strong as the income statement would suggest. We like that it has been delivering solid improvement in its earnings per share, and relatively consistent dividend payments. McGrath RentCorp performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 3 McGrath RentCorp 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%.

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.