Is Encompass Health Corporation (NYSE:EHC) A Smart Pick For Income Investors?

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Is Encompass Health Corporation (NYSE:EHC) a good dividend stock? How would you know? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

With a 1.7% yield and a six-year payment history, investors probably think Encompass Health looks like a reliable dividend stock. While the yield may not look too great, the relatively long payment history is interesting. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

Click the interactive chart for our full dividend analysis

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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. Encompass Health paid out 34% of its profit as dividends, over the trailing twelve month period. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Encompass Health paid out 24% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable.

Is Encompass Health's Balance Sheet Risky?

As Encompass Health has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments on debt. Essentially we check that a) a company does not have too much debt, and b) that it can afford to pay the interest. Encompass Health is carrying net debt of 3.09 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.

Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 4.70 times its interest expense, Encompass Health's interest cover is starting to look a bit thin.

We update our data on Encompass Health every 24 hours, so you can always get our latest analysis of its financial health, here.

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. Encompass Health has been paying a dividend for the past six years. Its dividend has not fluctuated much that time, which we like, but we're conscious that the company might not yet have a track record of maintaining dividends in all economic conditions. During the past six-year period, the first annual payment was US$0.72 in 2013, compared to US$1.08 last year. This works out to be a compound annual growth rate (CAGR) of approximately 7.0% a year over that time.