Is Carlo Gavazzi Holding AG (VTX:GAV) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

In this case, Carlo Gavazzi Holding likely looks attractive to investors, given its 4.6% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. Some simple analysis can reduce the risk of holding Carlo Gavazzi Holding for its dividend, and we'll focus on the most important aspects below.

Explore this interactive chart for our latest analysis on Carlo Gavazzi Holding!

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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. In the last year, Carlo Gavazzi Holding paid out 80% of its profit as dividends. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Carlo Gavazzi Holding paid out 132% of its free cash flow last year, which we think is concerning if cash flows do not improve. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. Carlo Gavazzi Holding paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Carlo Gavazzi Holding to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

With a strong net cash balance, Carlo Gavazzi Holding investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on Carlo Gavazzi Holding's financial position here.

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. For the purpose of this article, we only scrutinise the last decade of Carlo Gavazzi Holding's dividend payments. The dividend has been stable over the past 10 years, which is great. We think this could suggest some resilience to the business and its dividends. During the past ten-year period, the first annual payment was CHF5.00 in 2009, compared to CHF12.00 last year. Dividends per share have grown at approximately 9.1% per year over this time.

Companies like this, growing their dividend at a decent rate, can be very valuable over the long term, if the rate of growth can be maintained.

Dividend Growth Potential

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. Carlo Gavazzi Holding's EPS are effectively 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.

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. First, the company has a payout ratio that was within an average range for most dividend stocks, but it paid out virtually all of its generated cash flow. Second, earnings per share have actually shrunk, but at least the dividends have been relatively stable. In summary, Carlo Gavazzi Holding has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are a number of better ideas out there.

Are management backing themselves to deliver performance? Check their shareholdings in Carlo Gavazzi Holding in our latest insider ownership analysis.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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.