Is Dinkelacker AG (BST:DWB) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

Investors might not know much about Dinkelacker's dividend prospects, even though it has been paying dividends for the last seven years and offers a 1.8% yield. A 1.8% yield is not inspiring, but the longer payment history has some appeal. There are a few simple ways to reduce the risks of buying Dinkelacker for its dividend, and we'll go through these below.

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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. Looking at the data, we can see that 69% of Dinkelacker's profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. With a cash payout ratio of 189%, Dinkelacker's dividend payments are poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. While Dinkelacker's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Dinkelacker's ability to maintain its dividend.

Remember, you can always get a snapshot of Dinkelacker'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. Dinkelacker has been paying a dividend for the past seven years. The company has been paying a stable dividend for a while now, which is great. However we'd prefer to see consistency for a few more years before giving it our full seal of approval. During the past seven-year period, the first annual payment was €26.00 in 2013, compared to €32.00 last year. Dividends per share have grown at approximately 3.0% per year over this 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

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. Dinkelacker has grown its earnings per share at 5.3% per annum over the past five years. The rate at which earnings have grown is quite decent, and by paying out more than half of its earnings as dividends, the company is striking a reasonable balance between reinvestment and returns to shareholders.

Conclusion

To summarise, shareholders should always check that Dinkelacker's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Dinkelacker has an acceptable payout ratio, although its dividend was not well covered by cashflow. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we'd like. In summary, Dinkelacker has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives out there.

See if management have their own wealth at stake, by checking insider shareholdings in Dinkelacker stock.

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.

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. Thank you for reading.