Is Adairs Limited (ASX:ADH) A Great Dividend Stock?

Simply Wall St

Mon, Jul 8, 2019, 7:14 PM

Dividend paying stocks like Adairs Limited (ASX:ADH) 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.

Adairs yields a solid 9.9%, although it has only been paying for three years. It's certainly an attractive yield, but readers are likely curious about its staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

ASX:ADH Historical Dividend Yield, July 9th 2019

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Adairs paid out 76% of its profit as dividends, over the trailing twelve month period. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. The company paid out 77% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. It's positive to see that Adairs's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Remember, you can always get a snapshot of Adairs's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

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. During the past three-year period, the first annual payment was AU$0.10 in 2016, compared to AU$0.14 last year. This works out to be a compound annual growth rate (CAGR) of approximately 13% a year over that time.

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

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. It's good to see Adairs has been growing its earnings per share at 32% a year over the past 5 years. A majority of profits are being paid out as dividends, which raises the question of what happens to the current dividend if earnings decline. However, the rapid growth in earnings may indicate that is less of a risk.

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. Adairs's is paying out more than half its income as dividends, but at least the dividend is covered by both reported earnings and cashflow. 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. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Adairs out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 7 analysts we track are forecasting for Adairs for free with public analyst estimates for the company.

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.

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