Dividend paying stocks like City Chic Collective Limited (ASX:CCX) 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.

A slim 2.5% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, City Chic Collective could have potential. Some simple analysis can reduce the risk of holding City Chic Collective for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on City Chic Collective!

Payout ratios

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. Looking at the data, we can see that 34% of City Chic Collective's profits were paid out as dividends in the last 12 months. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while City Chic Collective pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

We update our data on City Chic Collective every 24 hours, so you can always get our latest analysis of its financial health, 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. For the purpose of this article, we only scrutinise the last decade of City Chic Collective'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 AU$0.08 in 2009, compared to AU$0.05 last year. The dividend has shrunk at around 4.6% a year during that period. City Chic Collective's dividend has been cut sharply at least once, so it hasn't fallen by 4.6% every year, but this is a decent approximation of the long term change.

A shrinking dividend over a ten-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

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? City Chic Collective has grown its earnings per share at 2.7% per annum over the past five years. A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?

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. First, we like City Chic Collective's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. Ultimately, City Chic Collective comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 4 analysts we track are forecasting for City Chic Collective for free with public analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.