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Know This Before Buying Oil Search Limited (ASX:OSH) For Its Dividend

Is Oil Search Limited (ASX:OSH) 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.

In this case, Oil Search likely looks attractive to investors, given its 5.7% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. Remember that the recent share price drop will make Oil Search's yield look higher, even though recent events might have impacted the company's prospects. Some simple research can reduce the risk of buying Oil Search for its dividend - read on to learn more.

Click the interactive chart for our full dividend analysis

ASX:OSH Historical Dividend Yield April 24th 2020
ASX:OSH Historical Dividend Yield April 24th 2020

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. Oil Search paid out 46% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

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In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Last year, Oil Search paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Is Oil Search's Balance Sheet Risky?

As Oil Search 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). Oil Search has net debt of 2.85 times its EBITDA. Using debt can accelerate business growth, but also increases the risks.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. Interest cover of 3.01 times its interest expense is starting to become a concern for Oil Search, and be aware that lenders may place additional restrictions on the company as well.

Remember, you can always get a snapshot of Oil Search's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. Oil Search 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 been cut one or more times over this time. During the past ten-year period, the first annual payment was US$0.04 in 2010, compared to US$0.095 last year. This works out to be a compound annual growth rate (CAGR) of approximately 9.0% a year over that time. Oil Search's dividend payments have fluctuated, so it hasn't grown 9.0% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Oil Search might have put its house in order since then, but we remain cautious.

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. In the last five years, Oil Search's earnings per share have shrunk at approximately 3.0% per annum. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

Conclusion

To summarise, shareholders should always check that Oil Search's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Oil Search has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Earnings per share are down, and Oil Search's dividend has been cut at least once in the past, which is disappointing. With this information in mind, we think Oil Search may not be an ideal dividend stock.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we've picked out 3 warning signs for Oil Search that investors should take into consideration.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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.

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. Thank you for reading.