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Dividend paying stocks like Mainova AG (FRA:MNV6) 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.

With a 2.8% yield and a nine-year payment history, investors probably think Mainova looks like a reliable dividend stock. While the yield may not look too great, the relatively long payment history is interesting. Some simple research can reduce the risk of buying Mainova for its dividend - read on to learn more.

Explore this interactive chart for our latest analysis on Mainova!

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. 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, Mainova paid out 35% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. 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. The company paid out 70% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Mainova has available to meet other needs. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Is Mainova's Balance Sheet Risky?

As Mainova 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 on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. With net debt of above 3x EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 4.30 times its interest expense, Mainova's interest cover is starting to look a bit thin.

Remember, you can always get a snapshot of Mainova's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the last decade of data, we can see that Mainova paid its first dividend at least nine years ago. The dividend has been quite stable over the past nine years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past nine-year period, the first annual payment was €9.48 in 2010, compared to €10.84 last year. This works out to be a compound annual growth rate (CAGR) of approximately 1.5% a year over that time.

Modest dividend growth is good to see, especially with the payments being relatively stable. However, the payment history is relatively short and we wouldn't want to rely on this dividend too much.

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. Earnings have grown at around 2.4% a year for the past five years, which is better than seeing them shrink! Mainova is paying out less than half of its earnings, which we like. Earnings per share growth have grown slowly, which is not great, but if the retained earnings can be reinvested effectively, future growth may be stronger.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Firstly, we like that Mainova pays out a low fraction of earnings. It pays out a higher percentage of its cashflow, although this is within acceptable bounds. Unfortunately, earnings growth has also been mediocre, and we think it has not been paying dividends long enough to demonstrate resilience across economic cycles. In sum, we find it hard to get excited about Mainova from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

You can also discover whether shareholders are aligned with insider interests by checking our visualisation of insider shareholdings and trades in Mainova stock.

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.