Do Investors Have Good Reason To Be Wary Of Coca-Cola Amatil Limited's (ASX:CCL) 3.6% Dividend Yield?

Is Coca-Cola Amatil Limited (ASX:CCL) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

With Coca-Cola Amatil yielding 3.6% and having paid a dividend for over 10 years, many investors likely find the company quite interesting. It would not be a surprise to discover that many investors buy it for the dividends. There are a few simple ways to reduce the risks of buying Coca-Cola Amatil for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Coca-Cola Amatil!

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. 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 92% of Coca-Cola Amatil's profits were paid out as dividends in the last 12 months. With a payout ratio this high, we'd say its dividend is not well covered by earnings. This may be fine if earnings are growing, but it might not take much of a downturn for the dividend to come under pressure.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. The company paid out 85% of its free cash flow as dividends last year, which is adequate, but reduces the wriggle room in the event of a downturn. While the dividend was not well covered by profits, at least they were covered by free cash flow. Still, if the company continues paying out such a high percentage of its profits, the dividend could be at risk if business turns sour.

Is Coca-Cola Amatil's Balance Sheet Risky?

As Coca-Cola Amatil's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and 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. Coca-Cola Amatil has net debt of 1.52 times its EBITDA, which is generally an okay level of debt for most companies.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Coca-Cola Amatil has EBIT of 5.56 times its interest expense, which we think is adequate.

We update our data on Coca-Cola Amatil 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 Coca-Cola Amatil's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past ten-year period, the first annual payment was AU$0.43 in 2010, compared to AU$0.47 last year. Dividend payments have grown at less than 1% a year over this period.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

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 7.4% a year for the past five years, which is better than seeing them shrink! Although per-share earnings are growing at a credible rate, virtually all of the income is being paid out as dividends to shareholders. This is okay, but may limit growth in the company's future dividend payments.

Conclusion

To summarise, shareholders should always check that Coca-Cola Amatil's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're not keen on the fact that Coca-Cola Amatil paid out such a high percentage of its income, although its cashflow is in better shape. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. In summary, Coca-Cola Amatil has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 13 Coca-Cola Amatil analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.

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. Thank you for reading.