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Three Things You Should Check Before Buying KAP AG (ETR:IUR) For Its Dividend

Simply Wall St

Dividend paying stocks like KAP AG ( ETR:IUR ) 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. 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.

In this case, KAP likely looks attractive to investors, given its 8.1% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. Some simple research can reduce the risk of buying KAP for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on KAP!

XTRA:IUR Historical Dividend Yield, August 16th 2019

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. Looking at the data, we can see that 297% of KAP's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. KAP paid out 196% of its free cash flow last year, which we think is concerning if cash flows do not improve. 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. As KAP's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

Is KAP's Balance Sheet Risky?

As KAP's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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. With net debt of 2.60 times its EBITDA, KAP's debt burden is within a normal range for most listed companies.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 3.02 times its interest expense is starting to become a concern for KAP, and be aware that lenders may place additional restrictions on the company as well.

Remember, you can always get a snapshot of KAP'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. KAP has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was €1.50 in 2009, compared to €2.00 last year. This works out to be a compound annual growth rate (CAGR) of approximately 2.9% a year over that time.

Slow and steady dividend growth might not sound that exciting, but dividends have been stable for ten years, which we think is seriously impressive.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see KAP has grown its earnings per share at 55% per annum over the past five years. The company has been growing its EPS at a very rapid rate, while paying out virtually all of its income as dividends. Generally, a company that is growing rapidly while paying out a majority of its earnings, is seeing its debt burden increase. We'd be conscious of any extra risk added by this practice.

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 a bit uncomfortable with KAP paying out a high percentage of both its cashflow and earnings. Earnings per share have not been growing, but we respect a company that maintains a relatively stable dividend. Ultimately, KAP comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

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

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.