Do Investors Have Good Reason To Be Wary Of Saras S.p.A.'s (BIT:SRS) 7.0% Dividend Yield?

Is Saras S.p.A. (BIT:SRS) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

A high yield and a long history of paying dividends is an appealing combination for Saras. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this 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. 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 142% of Saras's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Last year, Saras paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

With a strong net cash balance, Saras investors may not have much to worry about in the near term from a dividend perspective.

Remember, you can always get a snapshot of Saras'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. Saras has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. Its dividend payments have declined on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was €0.17 in 2010, compared to €0.08 last year. This works out to be a decline of approximately 7.3% per year over that time. Saras's dividend has been cut sharply at least once, so it hasn't fallen by 7.3% every year, but this is a decent approximation of the long term change.

We struggle to make a case for buying Saras for its dividend, given that payments have shrunk over the past ten years.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. It's good to see Saras has been growing its earnings per share at 30% a year over the past five years. Earnings per share have been growing very rapidly, although the company is also paying out virtually all of its profit in dividends. Generally, a company that is growing rapidly while paying out a majority of its earnings, is seeing its debt burden increase. We'd be conscious of any extra risk added by this practice.

Conclusion

To summarise, shareholders should always check that Saras's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. In summary, Saras has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 7 Saras analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.

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.