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Today we'll take a closer look at The Bombay Dyeing and Manufacturing Company Limited (NSE:BOMDYEING) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

While Bombay Dyeing and Manufacturing's 1.5% dividend yield is not the highest, we think its lengthy payment history is quite interesting. There are a few simple ways to reduce the risks of buying Bombay Dyeing and Manufacturing for its dividend, and we'll go through these below.

Click the interactive chart for our full dividend analysis

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Bombay Dyeing and Manufacturing paid out 2.5% of its profit as dividends, over the trailing twelve month period. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.

Is Bombay Dyeing and Manufacturing's Balance Sheet Risky?

As Bombay Dyeing and Manufacturing 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 2.26 times its EBITDA, Bombay Dyeing and Manufacturing'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 3.43 times its interest expense, Bombay Dyeing and Manufacturing's interest cover is starting to look a bit thin.

Remember, you can always get a snapshot of Bombay Dyeing and Manufacturing's latest financial position, by checking our visualisation of its financial health.

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. For the purpose of this article, we only scrutinise the last decade of Bombay Dyeing and Manufacturing's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was ₹0.20 in 2009, compared to ₹1.50 last year. This works out to be a compound annual growth rate (CAGR) of approximately 22% a year over that time. Bombay Dyeing and Manufacturing's dividend payments have fluctuated, so it hasn't grown 22% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. It's good to see Bombay Dyeing and Manufacturing has been growing its earnings per share at 119% a year over the past 5 years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.

Conclusion

To summarise, shareholders should always check that Bombay Dyeing and Manufacturing'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 Bombay Dyeing and Manufacturing is paying out a low percentage of its earnings and cash flow. 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. Overall we think Bombay Dyeing and Manufacturing scores well on our analysis. It's not quite perfect, but we'd definitely be keen to take a closer look.

You can also discover whether shareholders are aligned with insider interests by checking our visualisation of insider shareholdings and trades in Bombay Dyeing and Manufacturing stock.

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.