Today we'll take a closer look at Baker Hughes, a GE company (NYSE:BHGE) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

In this case, Baker Hughes a GE pays a decent-sized 3.4% dividend yield, and has been distributing cash to shareholders for the past two years. A 3.4% yield does look good. Could the short payment history hint at future dividend growth? The company also bought back stock equivalent to around 6.6% of market capitalisation this year. There are a few simple ways to reduce the risks of buying Baker Hughes a GE for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Baker Hughes a GE!

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. 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. Looking at the data, we can see that 205% of Baker Hughes a GE's profits were paid out as dividends in the last 12 months. 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. Baker Hughes a GE paid out 63% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Baker Hughes a GE fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

Is Baker Hughes a GE's Balance Sheet Risky?

As Baker Hughes a GE's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. 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 1.41 times its EBITDA, Baker Hughes a GE has an acceptable level of debt.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Net interest cover of 6.60 times its interest expense appears reasonable for Baker Hughes a GE, although we're conscious that even high interest cover doesn't make a company bulletproof.

We update our data on Baker Hughes a GE every 24 hours, so you can always get our latest analysis of its financial health, 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 dividend has not fluctuated much, but with a relatively short payment history, we can't be sure this is sustainable across a full market cycle. During the past two-year period, the first annual payment was US$0.68 in 2017, compared to US$0.72 last year. Dividends per share have grown at approximately 2.9% per year over this time.

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

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. Baker Hughes a GE's earnings per share are up 245% on last year. We're glad to see EPS up on last year, but we're conscious that growth rates typically slow as companies increase in size. The company has been growing its EPS at a very rapid rate, while paying out virtually all of its income as dividends. While EPS could grow fast enough to make the dividend sustainable, in this type of situation, we'd want to pay extra attention to any fragilities in the company's balance sheet. We do note though, one year is too short a time to be drawing strong conclusions about a company's future prospects.

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 Baker Hughes a GE paid out such a high percentage of its income, although its cashflow is in better shape. Second, the company has not been able to generate earnings growth, and its history of dividend payments too short for us to thoroughly evaluate the dividend's consistency across an economic cycle. In sum, we find it hard to get excited about Baker Hughes a GE 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.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 26 analysts we track are forecasting for Baker Hughes a GE for free with public analyst estimates for the company.

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.