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Do Investors Have Good Reason To Be Wary Of Dixons Carphone plc's (LON:DC.) 5.7% Dividend Yield?

Simply Wall St

Could Dixons Carphone plc (LON:DC.) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a nine-year payment history and a 5.7% yield, many investors probably find Dixons Carphone intriguing. We'd agree the yield does look enticing. Some simple analysis can reduce the risk of holding Dixons Carphone for its dividend, and we'll focus on the most important aspects below.

Click the interactive chart for our full dividend analysis

LSE:DC. Historical Dividend Yield, October 8th 2019

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. 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. Although it reported a loss over the past 12 months, Dixons Carphone currently pays a dividend. When a company is loss-making, we next need to check to see if its cash flows can support the dividend.

Dixons Carphone paid out 97% of its free cash flow last year, which we think is concerning if cash flows do not improve.

Is Dixons Carphone's Balance Sheet Risky?

Given Dixons Carphone is paying a dividend but reported a loss over the past year, 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 0.50 times its EBITDA, Dixons Carphone 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 7.94 times its interest expense appears reasonable for Dixons Carphone, although we're conscious that even high interest cover doesn't make a company bulletproof.

Consider getting our latest analysis on Dixons Carphone's financial position here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. The first recorded dividend for Dixons Carphone, in the last decade, was nine years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once by more than 20%, and we're cautious about the consistency of its dividend across a full economic cycle. During the past nine-year period, the first annual payment was UK£0.045 in 2010, compared to UK£0.068 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.6% a year over that time. Dixons Carphone's dividend payments have fluctuated, so it hasn't grown 4.6% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

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

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Dixons Carphone's earnings per share have shrunk at 37% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Dixons Carphone's earnings per share, which support the dividend, have been anything but stable.

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. It's a concern to see that the company paid a dividend despite reporting a loss, and the dividend was also not well covered by free cash flow. Earnings per share are down, and Dixons Carphone's dividend has been cut at least once in the past, which is disappointing. There are a few too many issues for us to get comfortable with Dixons Carphone 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. See if the 12 analysts are forecasting a turnaround in our free collection of analyst estimates here.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 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.