Consider this before buying Precision Camshafts Limited (NSE:PRECAM) for the 2.1% dividend

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Dividend paying stocks like Precision Camshafts Limited (NSE:PRECAM) tend to be popular with investors, and for good reason: some research suggests that a significant portion of all stock market returns come from reinvested dividends. Unfortunately, it’s common for investors to be lured in by the seemingly attractive yield, only to lose money when the company has to cut its dividend payments.

With a payment history of just three years and a yield of 2.1%, investors probably think that Precision Camshafts isn’t really a dividend stock. A low dividend might not be a bad thing, if the company reinvests heavily and grows its sales and profits. However, before buying a stock for its dividend, you should always remember Warren Buffett’s two rules: 1) Don’t lose money and 2) Remember rule #1. We’ll do some fact-checking below to help you out.

Explore this interactive chart for our latest analysis on precision camshafts!

Distribution rate

Dividends are typically paid out of company profits. If a company pays out more than it earns, then the dividend can become unsustainable, which is not an ideal situation. So we need to get a sense of how sustainable a company’s dividend is relative to its net profit after tax. Looking at the data, we can see that 59% of Precision Camshafts’ profits were paid out as dividends over the last 12 months. This is a fairly normal payout ratio for most companies. It allows for a higher dividend to be paid to shareholders, but limits the amount of capital retained in the business, which can be good or bad.

We update our data on Precision Camshafts every 24 hours, so you can always get our latest analysis of its financial health, right here.

Dividend Volatility

From the perspective of an investor who wants to receive dividends for many years, there is little point in buying a stock if its dividend is regularly cut or is unreliable. The company has been paying a stable dividend for a few years now, but we would like to see more evidence of consistency over a longer period. Its most recent annual dividend was ₹1.00 per share, which is about the same as when it first paid out three years ago.

The story continues

The modest dividend growth is a good thing, especially since the payments are relatively stable. However, the payment history is relatively short and we wouldn’t want to rely too much on this dividend.

Dividend growth potential

It is important to check whether the dividend is affordable and stable. However, it is also important to assess whether the earnings per share (EPS) are growing. In the long term, dividends need to grow at the same rate as inflation, or even above, in order to maintain the recipient’s purchasing power. Over the last five years, Precision Camshafts’ earnings per share have declined by around 3.8% per year. If earnings continue to decline, the dividend could come under pressure. Every investor should assess whether the company is taking steps to stabilize the situation.

Conclusion

Dividend investors should always want to know whether a) a company’s dividends are affordable, b) whether it has a track record of consistent payments, and c) whether the dividend is likely to grow. Precision Camshafts’ payout ratios are within a normal range for an average company, and we like that its cash flow is stronger than reported earnings. Second, earnings per share are falling and the dividend history is shorter than we’d like. Ultimately, Precision Camshafts falls short of our dividend analysis. It’s not that we think it’s a bad company – just that there are probably more attractive dividend prospects based on this analysis.

Is management giving itself the means to deliver performance? Find out more about their holdings in Precision Camshafts in our latest insider ownership analysis.

If you’re a dividend investor, you may also want to check out our curated list of dividend stocks yielding over 3%.

Our goal is to provide you with targeted, long-term research analysis based on fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative information.

If you spot an error that needs to be corrected, please contact the editor at [email protected]. This Simply Wall St article is general in nature. It is not a recommendation to buy or sell any stock, and does not take into account your objectives or financial situation. Simply Wall St has no position in any stock mentioned. Thank you for reading.