Dividend paying stocks like Topdanmark A/S (CPH:TOP) 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.
Topdanmark pays a 5.0% dividend yield, and has been paying dividends for the past two years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.
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. In the last year, Topdanmark paid out 95% of its profit as dividends. This is quite a high payout ratio that suggests the dividend is not well covered by earnings.
Remember, you can always get a snapshot of Topdanmark's latest financial position, by checking our visualisation of its financial health.
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. This company's dividend has been unstable, and with a relatively short history, we think it's a little soon to draw strong conclusions about its long term dividend potential. During the past two-year period, the first annual payment was ø19.00 in 2017, compared to ø15.00 last year. Dividend payments have fallen sharply, down 21% over that time.
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
Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Earnings have grown at around 5.0% a year for the past five years, which is better than seeing them shrink! Still, the company has struggled to grow its EPS, and currently pays out 95% of its earnings. Limited recent earnings growth and a high payout ratio makes it hard for us to envision strong future dividend growth, unless the company should have substantial pricing power or some form of competitive advantage.
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 a bit uncomfortable with its high payout ratio. Second, earnings growth has been ordinary, and its history of dividend payments is chequered - having cut its dividend at least once in the past. With this information in mind, we think Topdanmark may not be an ideal dividend stock.
Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 10 analysts we track are forecasting for Topdanmark for free with public 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 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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