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Does Melrose Industries PLC (LON:MRO) Have A Place In Your Dividend Stock Portfolio?

Simply Wall St

Is Melrose Industries PLC (LON:MRO) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

A 1.9% yield is nothing to get excited about, but investors probably think the long payment history suggests Melrose Industries has some staying power. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

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LSE:MRO Historical Dividend Yield, January 3rd 2020

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Although it reported a loss over the past 12 months, Melrose Industries currently pays a dividend. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

With a cash payout ratio of 245%, Melrose Industries's dividend payments are poorly 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.

We update our data on Melrose Industries 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. Melrose Industries has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was UK£0.78 in 2010, compared to UK£0.046 last year. The dividend has fallen 94% over that period.

A shrinking dividend over a ten-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Melrose Industries's EPS have fallen by approximately 54% per year during the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Melrose Industries's earnings per share, which support the dividend, have been anything but stable.

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. Melrose Industries's dividend is not well covered by free cash flow, plus it paid a dividend while being unprofitable. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. Using these criteria, Melrose Industries looks quite suboptimal from a dividend investment perspective.

Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting 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.