With interest rates still sitting near record lows, investors looking for current income have been forced to move from fixed-income positions and into stocks to find yield. To help offset those risks, one of the first things dividend investors do is look for companies operating in defensive industries like Quality Systems (NASDAQ:NXGN). But before doing the foolish thing and taking this dividend for granted, let's take a closer look at whether it's truly worthy of a spot in your portfolio.
Health is priceless; health care isn't.
As an electronic health records specialist, Quality Systems benefits from many of the unique elements of the industry that make it attractive for dividend investors. We all know it's impossible to put a price on one's health and well-being. Because of that, the health care sector at large is much less sensitive downturns in consumer spending. This dynamic, along with the aging and increasingly unhealthy society that we're all well aware of, is a key reason health care spending will continue to grow.
But while these big picture trends might be driving the overall industry, investors looking at specific health care dividend stocks need to dig a layer deeper to understand the company-specific issues at work. After all, dividends aren't a guarantee, and if the going gets tough enough, even a "stable" health care stock could cut -- or eliminate -- its dividend. With that being said, let's check on where Quality Systems' dividend has been, and try to determine where it's going.
A quick-and-dirty technique for checking a dividend's sustainability is taking a look at something called the payout ratio. Typically this is expressed as a percentage, looking at a company's dividend per share relative to its net income per share. That's a decent start, but I prefer to use a slightly different measurement that replaces net income, an accounting measurement, with something more tangible -- cold hard cash. The chart below shows how much of Quality Systems' free cash flow has been eaten up by its dividend payments over the past two years. The lower the better, suggesting more capacity for future dividend hikes.
Not all dividends are created equal. At first glance a high dividend yield may look nice, but all too often it means a problem is lurking around the corner for a business. Looking at Quality Systems' 3.9% dividend yield in isolation only tells half of the story, which is why investors need to have an understanding of how the market perceives a company prior to buying a stock. We can do this by comparing a few financial multiples, like price to earnings, to its peers in the industry.
Up to this point, we've looked at Quality Systems' dividend in the past, and we've also seen how its stock is being perceived by the market today. However, the most important factor to consider when understanding a dividend's future is where the company's cash flow is heading. It's hard to generate more cash without growing sales, so let's take a look at what industry analysts are expecting for Quality Systems' revenue growth relative to peers this year.
The metrics above paint a mixed picture for Quality Systems' dividend, but after digging into the details, it's clear to me that true dividend-focused investors should steer clear of Quality Systems. The company benefited for years as health care providers have invested in their IT infrastructure, but signs have emerged that suggest Quality Systems is falling behind the curve relative to the competition. Government incentives to implement electronic health records should support revenue growth for the next few years, but beyond that the demand outlook is largely unclear. That lack of long-term transparency, combined with an already high payout ratio, tells me investors should look somewhere other than Quality Systems for a rock solid dividend.
Brenton Flynn has no position in any stocks mentioned. The Motley Fool recommends Quality Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.