The board of Diploma PLC (LON:DPLM) has announced that it will be paying its dividend of ￡0.40 on the 2nd of February, an increased payment from last year's comparable dividend. Despite this raise, the dividend yield of 1.7% is only a modest boost to shareholder returns.

See our latest analysis for Diploma

Diploma's Payment Has Solid Earnings Coverage

Even a low dividend yield can be attractive if it is sustained for years on end. Based on the last payment, Diploma was quite comfortably earning enough to cover the dividend. This indicates that a lot of the earnings are being reinvested into the business, with the aim of fueling growth.

Looking forward, earnings per share is forecast to rise by 40.3% over the next year. If the dividend continues on this path, the payout ratio could be 52% by next year, which we think can be pretty sustainable going forward.

Dividend Volatility

While the company has been paying a dividend for a long time, it has cut the dividend at least once in the last 10 years. The dividend has gone from an annual total of ￡0.152 in 2014 to the most recent total annual payment of ￡0.565. This means that it has been growing its distributions at 14% per annum over that time. Diploma has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, so we would be cautious about buying this stock solely for the dividend income.

The Dividend Looks Likely To Grow

With a relatively unstable dividend, it's even more important to evaluate if earnings per share is growing, which could point to a growing dividend in the future. We are encouraged to see that Diploma has grown earnings per share at 13% per year over the past five years. Shareholders are getting plenty of the earnings returned to them, which combined with strong growth makes this quite appealing.

We Really Like Diploma's Dividend

Overall, a dividend increase is always good, and we think that Diploma is a strong income stock thanks to its track record and growing earnings. The company is easily earning enough to cover its dividend payments and it is great to see that these earnings are being translated into cash flow. All of these factors considered, we think this has solid potential as a dividend stock.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For example, we've picked out 2 warning signs for Diploma that investors should know about before committing capital to this stock. Is Diploma not quite the opportunity you were looking for? Why not check out our selection of top dividend stocks.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.