Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we'll take a closer look at Gravita India Limited (NSE:GRAVITA) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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 a 1.0% yield and a eight-year payment history, investors probably think Gravita India looks like a reliable dividend stock. While the yield may not look too great, the relatively long payment history is interesting. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

Click the interactive chart for our full dividend analysis

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. So we need to be 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 18% of Gravita India's profits were paid out as dividends in the last 12 months. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Unfortunately, while Gravita India 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.

Is Gravita India's Balance Sheet Risky?

As Gravita India has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A quick way to check a company's financial situation uses these two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. Gravita India has net debt of 2.97 times its earnings before interest, tax, depreciation, and amortisation (EBITDA). Using debt can accelerate business growth, but also increases the risks.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 3.47 times its interest expense, Gravita India's interest cover is starting to look a bit thin.

Remember, you can always get a snapshot of Gravita India'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. The first recorded dividend for Gravita India, in the last decade, was eight years ago. It's good to see that Gravita India has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past eight-year period, the first annual payment was ₹0.80 in 2011, compared to ₹0.70 last year. This works out to be a decline of approximately -1.7% per year over that time. Gravita India's dividend has been cut sharply at least once, so it hasn't fallen by -1.7% every year, but this is a decent approximation of the long term change.

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? Gravita India has grown its earnings per share at 6.9% per annum over the past five years. With a decent amount of growth and a low payout ratio, we think this bodes well for Gravita India's prospects of growing its dividend payments in the future.

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 Gravita India's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. In sum, we find it hard to get excited about Gravita India from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Are management backing themselves to deliver performance? Check their shareholdings in Gravita India in our latest insider ownership analysis.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.