Dividend paying stocks like On the Beach Group plc (LON:OTB) 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 popular dividend stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.
With only a three-year payment history, and a 1.5% yield, investors probably think On the Beach Group is not much of a dividend stock. Many of the best dividend stocks typically start out paying a low yield, so we wouldn’t automatically cut it from our list of prospects. Remember that the recent share price drop will make On the Beach Group’s yield look higher, even though recent events might have impacted the company’s prospects. Some simple research can reduce the risk of buying On the Beach Group for its dividend – read on to learn more.
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LSE:OTB Historical Dividend Yield March 27th 2020
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, On the Beach Group paid out 28% 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. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. On the Beach Group paid out a conservative 32% of its free cash flow as dividends last year. It’s encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don’t drop precipitously.
While the above analysis focuses on dividends relative to a company’s earnings, we do note On the Beach Group’s strong net cash position, which will let it pay larger dividends for a time, should it choose.
Consider getting our latest analysis on On the Beach Group’s financial position here.
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. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we’re not ready to live on. During the past three-year period, the first annual payment was UK£0.022 in 2017, compared to UK£0.033 last year. Dividends per share have grown at approximately 15% per year over this time. The dividends haven’t grown at precisely 15% every year, but this is a useful way to average out the historical rate of growth.
On the Beach Group has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.
Dividend Growth Potential
With a relatively unstable dividend, it’s even more important to evaluate if earnings per share (EPS) are growing – it’s not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Earnings have grown at around 9.9% a year for the past five years, which is better than seeing them shrink! Earnings per share have been growing at a credible rate. What’s more, the payout ratio is reasonable and provides some protection to the dividend, or even the potential to increase it.
Conclusion
To summarise, shareholders should always check that On the Beach Group’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that On the Beach Group has low and conservative payout ratios. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. On the Beach Group performs highly under this analysis, although it falls slightly short of our exacting standards. At the right valuation, it could be a solid dividend prospect.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. However, there are other things to consider for investors when analysing stock performance. For example, we’ve picked out 2 warning signs for On the Beach Group that investors should know about before committing capital to this stock.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
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.
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