Is The Scotts Miracle-Gro Company (NYSE:SMG) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

A 2.2% yield is nothing to get excited about, but investors probably think the long payment history suggests Scotts Miracle-Gro has some staying power. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Scotts Miracle-Gro paid out 34% of its profit as dividends, over the trailing twelve month period. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 58% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Scotts Miracle-Gro has available to meet other needs. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Is Scotts Miracle-Gro's Balance Sheet Risky?

As Scotts Miracle-Gro has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. 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 3.61 times its EBITDA, investors are starting to take on a meaningful amount of risk, should the business enter a downturn.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 4.75 times its interest expense, Scotts Miracle-Gro's interest cover is starting to look a bit thin.

We update our data on Scotts Miracle-Gro every 24 hours, so you can always get our latest analysis of its financial health, 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 Scotts Miracle-Gro's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past ten-year period, the first annual payment was US$0.50 in 2009, compared to US$2.32 last year. This works out to be a compound annual growth rate (CAGR) of approximately 17% a year over that time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

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. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Scotts Miracle-Gro has grown its earnings per share at 20% per annum over the past five years. With high earnings per share growth in recent times and a modest payout ratio, we think this is an attractive combination if earnings can be reinvested to generate further growth.

Conclusion

To summarise, shareholders should always check that Scotts Miracle-Gro's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Scotts Miracle-Gro's dividend payout ratios are within normal bounds, although we note its cash flow is not as strong as the income statement would suggest. Second, it has a limited history of earnings per share growth, but at least the dividends have been relatively stable. Overall we think Scotts Miracle-Gro scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.

Earnings growth generally bodes well for the future value of company dividend payments. See if the 7 Scotts Miracle-Gro analysts we track are forecasting continued growth with our free report on analyst estimates for the company.

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.