Should You Buy ARB Corporation Limited (ASX:ARB) For Its Dividend?

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Simply Wall St

Sun, Jun 30, 2019, 7:24 PM

Could ARB Corporation Limited (ASX:ARB) 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. 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 2.1% yield is nothing to get excited about, but investors probably think the long payment history suggests ARB 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.

Explore this interactive chart for our latest analysis on ARB!

ASX:ARB Historical Dividend Yield, July 1st 2019

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. ARB paid out 55% of its profit as dividends, over the trailing twelve month period. This is a healthy payout ratio, and while it does limit the amount of earnings that can be reinvested in the business, there is also some room to lift the payout ratio over time.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. ARB paid out 93% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. While ARB'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. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to ARB's ability to maintain its dividend.

Remember, you can always get a snapshot of ARB's latest financial position, by checking our visualisation of its financial health.

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. ARB has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was AU$0.15 in 2009, compared to AU$0.38 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.7% a year over that time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Earnings have grown at around 3.4% a year for the past five years, which is better than seeing them shrink! 3.4% per annum is not a particularly high rate of growth, which we find curious. If the company is struggling to grow, perhaps that's why it elects to pay out more than half of its earnings to shareholders.

Conclusion

To summarise, shareholders should always check that ARB's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think ARB has an acceptable payout ratio, although its dividend was not well covered by cashflow. Earnings growth has been limited, but we like that the dividend payments have been fairly consistent. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than ARB out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 6 ARB analysts we track are forecasting continued growth with our free report on 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%.

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.

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