Dividend paying stocks like Auswide Bank Ltd (ASX:ABA) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A high yield and a long history of paying dividends is an appealing combination for Auswide Bank. It would not be a surprise to discover that many investors buy it for the dividends. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.
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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Auswide Bank paid out 85% of its profit as dividends. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.
We update our data on Auswide Bank every 24 hours, so you can always get our latest analysis of its financial health, 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 Auswide Bank'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. During the past ten-year period, the first annual payment was AU$0.63 in 2009, compared to AU$0.34 last year. This works out to be a decline of approximately 5.8% per year over that time. Auswide Bank's dividend hasn't shrunk linearly at 5.8% per annum, but the CAGR is a useful estimate of the historical rate of change.
We struggle to make a case for buying Auswide Bank for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. While there may be fluctuations in the past , Auswide Bank's earnings per share have basically not grown from where they were five years ago. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. There are exceptions, but limited earnings growth and a high payout ratio can signal that a company is struggling to grow. When the rate of return on reinvestment opportunities falls below a certain minimum level, companies often elect to pay a larger dividend instead. This is why many mature companies often have larger dividend yields.