Dividend paying stocks like Playtech plc (LON:PTEC) 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 stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
While Playtech's 2.7% dividend yield is not the highest, we think its lengthy payment history is quite interesting. The company also bought back stock during the year, equivalent to approximately 2.9% of the company's market capitalisation at the time. Some simple analysis can reduce the risk of holding Playtech for its dividend, and we'll focus on the most important aspects below.
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. In the last year, Playtech paid out 200% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 52% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Playtech has available to meet other needs. It's good to see that while Playtech's dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.
Is Playtech's Balance Sheet Risky?
As Playtech's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 1.05 times its EBITDA, Playtech has an acceptable level of debt.
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 6.68 times its interest expense appears reasonable for Playtech, although we're conscious that even high interest cover doesn't make a company bulletproof.
We update our data on Playtech every 24 hours, so you can always get our latest analysis of its financial health, here.
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 Playtech'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 €0.15 in 2009, compared to €0.12 last year. The dividend has shrunk at around 2.2% a year during that period. Playtech's dividend has been cut sharply at least once, so it hasn't fallen by 2.2% every year, but this is a decent approximation of the long term change.
When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.
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? Playtech's EPS have fallen by approximately 44% 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 Playtech's earnings per share, which support the dividend, have been anything but stable.
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. We're not keen on the fact that Playtech paid out such a high percentage of its income, although its cashflow is in better shape. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. There are a few too many issues for us to get comfortable with Playtech from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.
Given that earnings are not growing, the dividend does not look nearly so attractive. Very few businesses see earnings consistently shrink year after year in perpetuity though, and so it might be worth seeing what the 9 analysts we track are forecasting for the future.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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