Dividend paying stocks like Ester Industries Limited (NSE:ESTER) tend to be popular with investors, and for good reason - some research suggests a significant amount of all stock market returns come from reinvested dividends. 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.

While Ester Industries's 1.6% dividend yield is not the highest, we think its lengthy payment history is quite interesting. Some simple analysis can reduce the risk of holding Ester Industries for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Ester Industries!

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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. In the last year, Ester Industries paid out 8.8% of its profit as dividends. We like this low payout ratio, because it implies the dividend is well covered and leaves ample opportunity for reinvestment.

Is Ester Industries's Balance Sheet Risky?

As Ester Industries has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) 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. Ester Industries has net debt of 1.90 times its EBITDA, which we think is not too troublesome.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 3.05 times its interest expense is starting to become a concern for Ester Industries, and be aware that lenders may place additional restrictions on the company as well.

Consider getting our latest analysis on Ester Industries's financial position here.

Dividend Volatility

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. For the purpose of this article, we only scrutinise the last decade of Ester Industries's dividend payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. Its most recent annual dividend was ₹0.50 per share, effectively flat on its first payment ten years ago.

Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Ester Industries has grown its earnings per share at 34% per annum over the past five years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.

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 glad to see Ester Industries has a low payout ratio, as this suggests earnings are being reinvested in the business. 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. Ester Industries fits all of our criteria, and we think there are a lot of positives to it from a dividend perspective.

Are management backing themselves to deliver performance? Check their shareholdings in Ester Industries in our latest insider ownership analysis.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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.