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Is Stantec Inc.'s (TSE:STN) 1.8% Dividend Worth Your Time?

Simply Wall St

Today we'll take a closer look at Stantec Inc. (TSE:STN) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.

Investors might not know much about Stantec's dividend prospects, even though it has been paying dividends for the last seven years and offers a 1.8% yield. A low yield is generally a turn-off, but if the prospects for earnings growth were strong, investors might be pleasantly surprised by the long-term results. The company also bought back stock during the year, equivalent to approximately 2.0% of the company's market capitalisation at the time. There are a few simple ways to reduce the risks of buying Stantec for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

TSX:STN Historical Dividend Yield, July 24th 2019

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Stantec paid out 35% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Stantec paid out 86% of its cash flow last year. This may be sustainable but it does not leave much of a buffer for unexpected circumstances. It's positive to see that Stantec's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

Is Stantec's Balance Sheet Risky?

As Stantec has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) 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. Stantec has net debt of 2.83 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Stantec has EBIT of 6.82 times its interest expense, which we think is adequate.

Remember, you can always get a snapshot of Stantec'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. Stantec has been paying a dividend for the past seven years. Its dividend has not fluctuated much that time, which we like, but we're conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past seven-year period, the first annual payment was CA$0.30 in 2012, compared to CA$0.58 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.9% a year over that time.

The dividend has been growing at a reasonable rate, which we like. We're conscious though that one of the best ways to detect a multi-decade consistent dividend-payer, is to watch a company pay dividends for 20 years - a distinction Stantec has not achieved yet.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Stantec's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Above all, we're glad to see that Stantec pays out a low fraction of its earnings and, while it paid a higher percentage of cashflow, this also was within a normal range. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Stantec out there.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 11 Stantec analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

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.

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. Thank you for reading.