Three Things You Should Check Before Buying ENCE Energía y Celulosa, S.A. (BME:ENC) For Its Dividend

Dividend paying stocks like ENCE Energía y Celulosa, S.A. (BME:ENC) 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. 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.

With a nine-year payment history and a 7.8% yield, many investors probably find ENCE Energía y Celulosa intriguing. It sure looks interesting on these metrics - but there's always more to the story . The company also bought back stock during the year, equivalent to approximately 3.2% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying ENCE Energía y Celulosa for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on ENCE Energía y Celulosa!

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. ENCE Energía y Celulosa paid out 40% of its profit as dividends, over the trailing twelve month period. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Plus, there is room to increase the payout ratio over time.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Unfortunately, while ENCE Energía y Celulosa pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

Is ENCE Energía y Celulosa's Balance Sheet Risky?

As ENCE Energía y Celulosa has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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. With net debt of 2.62 times its EBITDA, ENCE Energía y Celulosa has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. ENCE Energía y Celulosa has EBIT of 8.14 times its interest expense, which we think is adequate.

Consider getting our latest analysis on ENCE Energía y Celulosa's financial position 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. The first recorded dividend for ENCE Energía y Celulosa, in the last decade, was nine years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past nine-year period, the first annual payment was €0.10 in 2011, compared to €0.26 last year. Dividends per share have grown at approximately 11% per year over this time. ENCE Energía y Celulosa's dividend payments have fluctuated, so it hasn't grown 11% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

ENCE Energía y Celulosa 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 see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see ENCE Energía y Celulosa has grown its earnings per share at 72% per annum over the past five years. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever.

Conclusion

To summarise, shareholders should always check that ENCE Energía y Celulosa's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, the company has a conservative payout ratio, although we'd note that its cashflow in the past year was substantially lower than its reported profit. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than ENCE Energía y Celulosa out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 6 ENCE Energía y Celulosa 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.

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