Today we'll take a closer look at Persistent Systems Limited (NSE:PERSISTENT) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a 1.8% yield and a nine-year payment history, investors probably think Persistent Systems looks like a reliable dividend stock. A 1.8% yield is not inspiring, but the longer payment history has some appeal. The company also bought back stock during the year, equivalent to approximately 1.2% of the company's market capitalisation at the time. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 25% of Persistent Systems's profits were paid out as dividends in the last 12 months. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Persistent Systems's cash payout ratio last year was 22%, which is quite low and suggests that the dividend was thoroughly covered by cash flow.

With a strong net cash balance, Persistent Systems investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on Persistent Systems's financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. The first recorded dividend for Persistent Systems, in the last decade, was nine years ago. It's good to see that Persistent Systems 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 nine-year period, the first annual payment was ₹1.25 in 2010, compared to ₹11.00 last year. This works out to be a compound annual growth rate (CAGR) of approximately 27% a year over that time. Persistent Systems's dividend payments have fluctuated, so it hasn't grown 27% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

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? Persistent Systems has grown its earnings per share at 6.5% per annum over the past five years. Earnings per share have been growing at a credible rate. What's more, the payout ratio is reasonable and provides some protection to the dividend, or even the potential to increase it.

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. It's great to see that Persistent Systems is paying out a low percentage of its earnings and cash flow. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. Overall we think Persistent Systems is an interesting dividend stock, although it could be better.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 24 analysts we track are forecasting for Persistent Systems for free with public analyst estimates for the company.

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.