A passive income can be a game-changer for a number of reasons. It can help to start an emergency fund, offset the rising cost of living, and grow wealth over time. Many investors do so using dividend stocks, receiving a cash income. I’ve found one with a very appealing dividend yield, but is it perfect for income investors?
abrdn
Asset management provider abrdn (LSE: ABDN) offers a range of investment solutions and funds across Europe, North America and Asia. This giant of the industry has a market capitalisation of £3bn. The share price has disappointed lately, down over 20% in the last year as economic uncertainty sent the company into loss-making territory, dropping the company out of the FTSE 100.
What about the dividend?
As much as the share performance has disappointed, the dividend yield of 8.7% may be keeping investors interested. This generous yield sits inside the top 10 of the FTSE 250. When making an investment in a dividend-paying company, I always ensure there are healthy fundamentals to support this payment. If the business is functioning well, and is in a strong position to continue, then the dividend is likely to grow over time, but if times are tough, the dividend could quickly disappear, sending investors to the exit.
The dividend has been above 4.1% for the last decade or so. It has been generally increasing over time, but my concern is the lack of profits at present. With no earnings, the dividend isn’t currently sustainable, putting investors in an anxious position over the coming years.
Growth prospects
The firm isn’t alone in feeling the recent volatility of the market. Many other long-standing companies have been struggling, having to restructure and rethink their businesses following the impact of the pandemic. Losses have been generally narrowing in recent years, with a 13.7% average increase over the last five. More encouraging signs are that cash reserves far outweigh short and long-term debts. As a result of strong fundamentals, the business expects to be profitable within the next three years. Key managers, seem to be confident of this recovery, and have been buying its shares in recent months. I see this confidence as a positive sign (but it can just be a coincidence).
Valuation
With a business focused on a return to profitability, the current valuation of the share price really matters. There may be a real opportunity for investors if the share price is undervalued due to recent difficulties. The price-to-sales (P/S) ratio of 1.9 times is well below the average of the sector at 5.8 times, suggesting the company may be undervalued relative to competitors. However, based on a discounted cash flow, the current share price could already be over 20% overvalued. This suggests to me that investors are already expecting a reasonable recovery from a difficult few years, and that opportunities for growth may be limited.
Overall
There’s no doubt that the high dividend yield of 8.7% is appealing for those building a passive income. However, the performance of the business is critical to support this. I see the asset management sector recovering from a bumpy few years, but I suspect that the majority of this growth is already reflected in the share price. I’ll be steering clear for now.
