Yahoo Finance Do Investors Have Good Reason To Be Wary Of Elementis plc's (LON:ELM) 6.7% Dividend Yield?
Dividend paying stocks like Elementis plc (LON:ELM) 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. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.
With Elementis yielding 6.7% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. Remember that the recent share price drop will make Elementis's yield look higher, even though recent events might have impacted the company's prospects. 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 Elementis!
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. In the last year, Elementis paid out 83% of its profit as dividends. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Elementis paid out 116% of its free cash flow last year, which we think is concerning if cash flows do not improve. While Elementis's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Elementis to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.
Is Elementis's Balance Sheet Risky?
As Elementis 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. Elementis has net debt of 2.59 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.
We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Elementis has EBIT of 6.13 times its interest expense, which we think is adequate.
Consider getting our latest analysis on Elementis's financial position here.
Dividend Volatility
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. For the purpose of this article, we only scrutinise the last decade of Elementis's dividend payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was US$0.041 in 2010, compared to US$0.086 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.7% a year over that time. The dividends haven't grown at precisely 7.7% every year, but this is a useful way to average out the historical rate of growth.
A reasonable rate of dividend growth is good to see, but we're wary that the dividend history is not as solid as we'd like, having been cut at least once.
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? Over the past five years, it looks as though Elementis's EPS have declined at around 15% a year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.
We'd also point out that Elementis issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.
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. Elementis gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. 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, Elementis looks quite suboptimal from a dividend investment perspective.
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 12 analysts we track are forecasting for the future.
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.
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