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Dividend paying stocks like New England Realty Associates Limited Partnership (NYSEMKT:NEN) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

A 2.1% yield is nothing to get excited about, but investors probably think the long payment history suggests New England Realty Associates Limited Partnership has some staying power. The company also bought back stock during the year, equivalent to approximately 1.3% of the company's market capitalisation at the time. Some simple research can reduce the risk of buying New England Realty Associates Limited Partnership for its dividend - read on to learn more.

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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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. New England Realty Associates Limited Partnership paid out 120% 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. New England Realty Associates Limited Partnership paid out 18% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's good to see that while New England Realty Associates Limited Partnership's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Is New England Realty Associates Limited Partnership's Balance Sheet Risky?

As New England Realty Associates Limited Partnership'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 7.65 times its EBITDA, New England Realty Associates Limited Partnership could be described as a highly leveraged company. While some companies can handle this level of leverage, we'd be concerned about the dividend sustainability if there was any risk of an earnings downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Interest cover of 1.31 times its interest expense is starting to become a concern for New England Realty Associates Limited Partnership, and be aware that lenders may place additional restrictions on the company as well. High debt and weak interest cover are not a great combo, and we would be cautious of relying on this company's dividend while these metrics persist.

Consider getting our latest analysis on New England Realty Associates Limited Partnership'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. New England Realty Associates Limited Partnership has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was US$0.93 in 2009, compared to US$1.28 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.2% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? It's good to see New England Realty Associates Limited Partnership has been growing its earnings per share at 15% a year over the past 5 years. With a payout ratio of 120%, New England Realty Associates Limited Partnership is paying out dividends substantially greater than what it earned in profit.

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. We're not keen on the fact that New England Realty Associates Limited Partnership paid out such a high percentage of its income, although its cashflow is in better shape. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than New England Realty Associates Limited Partnership out there.

Now, if you want to look closer, it would be worth checking out our free research on New England Realty Associates Limited Partnership management tenure, salary, and performance.

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.