Today we'll take a closer look at Sims Limited (ASX:SGM) 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. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

With Sims yielding 6.1% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. We'd guess that plenty of investors have purchased it for the income. The company also bought back stock equivalent to around 1.6% of market capitalisation this year. Remember though, given the recent drop in its share price, Sims's yield will look higher, even though the market may now be expecting a decline in its long-term prospects. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Although Sims pays a dividend, it was loss-making during the past year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

Sims paid out 75% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances.

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

Remember, you can always get a snapshot of Sims'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. For the purpose of this article, we only scrutinise the last decade of Sims's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was AU$0.38 in 2010, compared to AU$0.42 last year. This works out to be a compound annual growth rate (CAGR) of approximately 1.0% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.