The board of Metcash Limited (ASX:MTS) has announced that it will pay a dividend on the 29th of January, with investors receiving A$0.085 per share. This means the annual payment is 5.1% of the current stock price, which is above the average for the industry.

View our latest analysis for Metcash

Metcash's Projected Earnings Seem Likely To Cover Future Distributions

Impressive dividend yields are good, but this doesn't matter much if the payments can't be sustained. Based on the last payment, Metcash was quite comfortably earning enough to cover the dividend. This means that a large portion of its earnings are being retained to grow the business.

Over the next year, EPS is forecast to expand by 25.3%. If the dividend continues along recent trends, we estimate the payout ratio will be 63%, which is in the range that makes us comfortable with the sustainability of the dividend.

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 A$0.185 in 2014 to the most recent total annual payment of A$0.17. The dividend has shrunk at a rate of less than 1% a year over this period. A company that decreases its dividend over time generally isn't what we are looking for.

The Dividend Looks Likely To Grow

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Metcash has impressed us by growing EPS at 25% per year over the past five years. The company doesn't have any problems growing, despite returning a lot of capital to shareholders, which is a very nice combination for a dividend stock to have.

We should note that Metcash has issued stock equal to 12% of shares outstanding. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.

Metcash Looks Like A Great Dividend Stock

It is generally not great to see the dividend being cut, but we don't think this should happen much if at all in the future given that Metcash has the makings of a solid income stock moving forward. The cut will allow the company to continue paying out the dividend without putting the balance sheet under pressure, which means that it could remain sustainable for longer. All of these factors considered, we think this has solid potential as a dividend stock.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For example, we've picked out 3 warning signs for Metcash that investors should know about before committing capital to this stock. If you are a dividend investor, you might also want to look at our curated list of high yield dividend stocks.

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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.