Today we'll take a closer look at Domain Holdings Australia Limited (ASX:DHG) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.
Some readers mightn't know much about Domain Holdings Australia's 1.9% dividend, as it has only been paying distributions for the last two years. Many of the best dividend stocks typically start out paying a low yield, so we wouldn't automatically cut it from our list of prospects. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
ASX:DHG Historical Dividend Yield, September 25th 2019
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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Although it reported a loss over the past 12 months, Domain Holdings Australia currently pays a dividend. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.
Domain Holdings Australia paid out 65% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business.
Is Domain Holdings Australia's Balance Sheet Risky?
Given Domain Holdings Australia is paying a dividend but reported a loss over the past year, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with 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. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Domain Holdings Australia has net debt of 1.48 times its EBITDA, which is generally an okay level of debt for most companies.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Domain Holdings Australia has EBIT of 9.25 times its interest expense, which we think is adequate.
From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past two-year period, the first annual payment was AU$0.08 in 2017, compared to AU$0.06 last year. This works out to a decline of approximately 25% over that time.
We struggle to make a case for buying Domain Holdings Australia for its dividend, given that payments have shrunk over the past two years.
Dividend Growth Potential
Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Domain Holdings Australia's earnings per share have fallen -850% over the past year. This is a pretty serious concern, and it would be worth investigating whether something fundamental in the business has changed - or broken. We do note though, one year is too short a time to be drawing strong conclusions about a company's future prospects.
Conclusion
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. We're not keen on the fact that Domain Holdings Australia paid dividends despite reporting a loss over the past year, although fortunately its dividend was covered by cash flow. Earnings per share are down, and Domain Holdings Australia's dividend has been cut at least once in the past, which is disappointing. Using these criteria, Domain Holdings Australia looks quite suboptimal from a dividend investment perspective.
Given that earnings are not growing, the dividend does not look nearly so attractive. See if the 8 analysts are forecasting a turnaround in our free collection of analyst estimates here.
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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.
