Is Laurus Labs Limited (NSE:LAURUSLABS) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

Some readers mightn't know much about Laurus Labs's 0.5% dividend, as it has only been paying distributions for the last two years. Many of the best dividend stocks typically start out paying a low yield, so we wouldn't automatically cut it from our list of prospects. There are a few simple ways to reduce the risks of buying Laurus Labs 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. Laurus Labs paid out 17% of its profit as dividends, over the trailing twelve month period. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Laurus Labs paid out a conservative 37% of its free cash flow as dividends last year. It's positive to see that Laurus Labs'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 Laurus Labs's Balance Sheet Risky?

As Laurus Labs 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 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 2.68 times its EBITDA, Laurus Labs's debt burden is within a normal range for most listed companies.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 2.93 times its interest expense, Laurus Labs's interest cover is starting to look a bit thin.

Consider getting our latest analysis on Laurus Labs'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. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. Its most recent annual dividend was ₹1.50 per share, effectively flat on its first payment two years ago.

It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.

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. Laurus Labs's EPS have fallen by approximately 11% per year. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

To summarise, shareholders should always check that Laurus Labs's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's great to see that Laurus Labs is paying out a low percentage of its earnings and cash flow. Earnings per share are down, and to our mind Laurus Labs has not been paying a dividend long enough to demonstrate its resilience across economic cycles. Ultimately, Laurus Labs comes up short on our dividend analysis. It's not that we think it is a bad company - just that there are likely more appealing dividend prospects out there on this analysis.

Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 6 analysts are forecasting a turnaround in our free collection of analyst estimates here.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.