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Today we'll take a closer look at N.V. Nederlandsche Apparatenfabriek Nedap (AMS:NEDAP) 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.
In this case, N.V. Nederlandsche Apparatenfabriek Nedap likely looks attractive to dividend investors, given its 5.2% dividend yield and nine-year payment history. We'd agree the yield does look enticing. 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.
ENXTAM:NEDAP Historical Dividend Yield, June 10th 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. 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 94% of N.V. Nederlandsche Apparatenfabriek Nedap's profits were paid out as dividends in the last 12 months. Its payout ratio is quite high, and the dividend is not well covered by earnings. If earnings are growing or the company has a large cash balance, this might be sustainable - still, we think it is a concern.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. N.V. Nederlandsche Apparatenfabriek Nedap paid out 141% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. Cash is slightly more important than profit from a dividend perspective, but given N.V. Nederlandsche Apparatenfabriek Nedap's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.
Is N.V. Nederlandsche Apparatenfabriek Nedap's Balance Sheet Risky?
As N.V. Nederlandsche Apparatenfabriek Nedap's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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. N.V. Nederlandsche Apparatenfabriek Nedap has net debt of 0.64 times its earnings before interest, tax, depreciation and amortisation (EBITDA), which is generally seen as an acceptable level of debt.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. N.V. Nederlandsche Apparatenfabriek Nedap has interest cover of more than 12 times its interest expense, which we think is quite strong.
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. Looking at the last decade of data, we can see that N.V. Nederlandsche Apparatenfabriek Nedap paid its first dividend at least nine years ago. It's good to see that N.V. Nederlandsche Apparatenfabriek Nedap 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 €0.14 in 2010, compared to €2.50 last year. Dividends per share have grown at approximately 38% per year over this time. N.V. Nederlandsche Apparatenfabriek Nedap's dividend payments have fluctuated, so it hasn't grown 38% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.
So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.
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. It's good to see N.V. Nederlandsche Apparatenfabriek Nedap has been growing its earnings per share at 13% a year over the past 5 years. Although earnings per share are up nicely N.V. Nederlandsche Apparatenfabriek Nedap is paying out 94% of its earnings as dividends, which we feel is borderline unsustainable without extenuating circumstances.
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. We're a bit uncomfortable with N.V. Nederlandsche Apparatenfabriek Nedap paying out a high percentage of both its cashflow and earnings. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Overall, N.V. Nederlandsche Apparatenfabriek Nedap falls short in several key areas here. Unless the investor has strong grounds for an alternative conclusion, we find it hard to get interested in a dividend stock with these characteristics.
Are management backing themselves to deliver performance? Check their shareholdings in N.V. Nederlandsche Apparatenfabriek Nedap in our latest insider ownership analysis.
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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.
