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Is It Worth Buying Cognizant Technology Solutions Corporation (NASDAQ:CTSH) For Its 1.3% Dividend Yield?

Simply Wall St

Dividend paying stocks like Cognizant Technology Solutions Corporation (NASDAQ:CTSH) 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. 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.

Some readers mightn't know much about Cognizant Technology Solutions's 1.3% dividend, as it has only been paying distributions for the last three years. Many of the best dividend stocks typically start out paying a low yield, so we wouldn't automatically cut it from our list of prospects. The company also bought back stock equivalent to around 6.3% of market capitalisation this year. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Explore this interactive chart for our latest analysis on Cognizant Technology Solutions!

NasdaqGS:CTSH Historical Dividend Yield, November 25th 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. 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. Cognizant Technology Solutions paid out 22% of its profit as dividends, over the trailing twelve month period. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Cognizant Technology Solutions's cash payout ratio last year was 25%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's positive to see that Cognizant Technology Solutions'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.

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

We update our data on Cognizant Technology Solutions 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. 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 three-year period, the first annual payment was US$0.60 in 2016, compared to US$0.80 last year. Dividends per share have grown at approximately 10% per year over this time.

We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.

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. It's good to see Cognizant Technology Solutions has been growing its earnings per share at 13% a year over the past five 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

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. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. Next, earnings growth has been good, but unfortunately the company has not been paying dividends as long as we'd like. All things considered, Cognizant Technology Solutions 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 28 Cognizant Technology Solutions analysts we track are forecasting continued growth with our free report on 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.