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Dividend paying stocks like The South Indian Bank Limited (NSE:SOUTHBANK) 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.
A 2.2% yield is nothing to get excited about, but investors probably think the long payment history suggests South Indian Bank 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.
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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. In the last year, South Indian Bank paid out 15% of its profit as dividends. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.
Remember, you can always get a snapshot of South Indian Bank'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. For the purpose of this article, we only scrutinise the last decade of South Indian Bank'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 ₹0.30 in 2009, compared to ₹0.25 last year. The dividend has shrunk at around 1.8% a year during that period. South Indian Bank's dividend hasn't shrunk linearly at 1.8% per annum, but the CAGR is a useful estimate of the historical rate of change.
We struggle to make a case for buying South Indian Bank for its dividend, given that payments have shrunk over the past ten years.
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. Over the past five years, it looks as though South Indian Bank's EPS have declined at around 15% a year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and South Indian Bank's earnings per share, which support the dividend, have been anything but stable.