Dividend paying stocks like nmcn plc (LON:NMCN) 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 the income from dividends, it's important to be a lot more stringent with your investments than the average punter.
In this case, nmcn likely looks attractive to dividend investors, given its 4.2% dividend yield and nine-year payment history. It sure looks interesting on these metrics - but there's always more to the story . Some simple analysis can reduce the risk of holding nmcn for its dividend, and we'll focus on the most important aspects below.
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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 be form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, nmcn paid out 38% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. nmcn paid out 4.7% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable.
While the above analysis focuses on dividends relative to a company's earnings, we do note nmcn's strong net cash position, which will let it pay larger dividends for a time, should it choose.
Remember, you can always get a snapshot of nmcn'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. Looking at the last decade of data, we can see that nmcn paid its first dividend at least nine years ago. It's good to see that nmcn 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 UK£0.085 in 2010, compared to UK£0.24 last year. This works out to be a compound annual growth rate (CAGR) of approximately 12% a year over that time. The dividends haven't grown at precisely 12% every year, but this is a useful way to average out the historical rate of growth.