Looking For Steady Income For Your Dividend Portfolio? Is Allgeier SE (ETR:AEIN) A Good Fit?

Dividend paying stocks like Allgeier SE (ETR:AEIN) 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.

Some readers mightn't know much about Allgeier's 1.4% dividend, as it has only been paying distributions for the last two years. A low dividend might not be a bad thing, if the company is reinvesting heavily and growing its sales and profits. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Allgeier paid out 131% of its profit as dividends, over the trailing twelve month period. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Allgeier paid out 31% as dividends, suggesting the dividend is affordable. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Allgeier fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is Allgeier's Balance Sheet Risky?

As Allgeier'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 measures total debt load relative to company earnings (lower = less debt), while net interest cover measures the ability to pay interest on the debt (higher = greater ability to pay interest costs). With net debt of 2.35 times its EBITDA, Allgeier's debt burden is within a normal range for most listed companies.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 3.89 times its interest expense is starting to become a concern for Allgeier, and be aware that lenders may place additional restrictions on the company as well.

Consider getting our latest analysis on Allgeier's financial position here.

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. The dividend has not fluctuated much, but with a relatively short payment history, we can't be sure this is sustainable across a full market cycle. Its most recent annual dividend was €0.50 per share, effectively flat on its first payment two years ago.

We like that the dividend hasn't been shrinking. However we're conscious that the company hasn't got an overly long track record of dividend payments yet, which makes us wary of relying on its dividend income.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. In the last five years, Allgeier's earnings per share have shrunk at approximately 8.3% per annum. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

We'd also point out that Allgeier issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Conclusion

To summarise, shareholders should always check that Allgeier'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 a bit uncomfortable with its high payout ratio, although at least the dividend was covered by free cash flow. Earnings per share have been falling, and the company has a relatively short dividend history - shorter than we like, anyway. With this information in mind, we think Allgeier may not be an ideal dividend stock.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 4 analysts are forecasting a turnaround in our free collection of analyst estimates here.

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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