The board of Nichols plc (LON:NICL) has announced that it will be increasing its dividend by 27% on the 9th of September to £0.124, up from last year's comparable payment of £0.098. This makes the dividend yield about the same as the industry average at 1.9%.

View our latest analysis for Nichols

Nichols Doesn't Earn Enough To Cover Its Payments

We aren't too impressed by dividend yields unless they can be sustained over time. Nichols is not generating a profit, but its free cash flows easily cover the dividend, leaving plenty for reinvestment in the business. In general, cash flows are more important than the more traditional measures of profit so we feel pretty comfortable with the dividend at this level.

Earnings per share is forecast to rise by 130.9% over the next year. However, if the dividend continues along recent trends, it could start putting pressure on the balance sheet with the payout ratio reaching 141% over the next year.

Dividend Volatility

The company has a long dividend track record, but it doesn't look great with cuts in the past. The annual payment during the last 10 years was £0.153 in 2012, and the most recent fiscal year payment was £0.231. This means that it has been growing its distributions at 4.2% per annum over that time. It's encouraging to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth anyway, which makes this less attractive as an income investment.

The Dividend Has Limited Growth Potential

Growing earnings per share could be a mitigating factor when considering the past fluctuations in the dividend. Nichols' EPS has fallen by approximately 46% per year during the past five years. Dividend payments are likely to come under some pressure unless EPS can pull out of the nosedive it is in. On the bright side, earnings are predicted to gain some ground over the next year, but until this turns into a pattern we wouldn't be feeling too comfortable.

The Dividend Could Prove To Be Unreliable

Overall, this is probably not a great income stock, even though the dividend is being raised at the moment. In the past, the payments have been unstable, but over the short term the dividend could be reliable, with the company generating enough cash to cover it. We would probably look elsewhere for an income investment.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 1 warning sign for Nichols that investors need to be conscious of moving forward. Is Nichols not quite the opportunity you were looking for? Why not check out our selection of top dividend stocks.