It looks like Diageo plc (LON:DGE) is about to go ex-dividend in the next three days. You will need to purchase shares before the 13th of August to receive the dividend, which will be paid on the 8th of October.
Diageo's next dividend payment will be UK£0.42 per share, and in the last 12 months, the company paid a total of UK£0.70 per share. Based on the last year's worth of payments, Diageo stock has a trailing yield of around 2.7% on the current share price of £25.67. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.
Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Diageo paid out 116% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance. A useful secondary check can be to evaluate whether Diageo generated enough free cash flow to afford its dividend. The company paid out 102% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Cash flows are usually much more volatile than earnings, so this could be a temporary effect - but we'd generally want look more closely here.
Cash is slightly more important than profit from a dividend perspective, but given Diageo's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.
Have Earnings And Dividends Been Growing?
Businesses with shrinking earnings are tricky from a dividend perspective. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. With that in mind, we're discomforted by Diageo's 8.8% per annum decline in earnings in the past five years. Such a sharp decline casts doubt on the future sustainability of the dividend.
The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the last 10 years, Diageo has lifted its dividend by approximately 6.8% a year on average. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Diageo is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.
Should investors buy Diageo for the upcoming dividend? It's looking like an unattractive opportunity, with its earnings per share declining, while, paying out an uncomfortably high percentage of both its profits (116%) and cash flow as dividends. This is a starkly negative combination that often suggests a dividend cut could be in the company's near future. It's not the most attractive proposition from a dividend perspective, and we'd probably give this one a miss for now.
With that in mind though, if the poor dividend characteristics of Diageo don't faze you, it's worth being mindful of the risks involved with this business. Our analysis shows 4 warning signs for Diageo that we strongly recommend you have a look at before investing in the company.
If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.
This article by Simply Wall St is general in nature. 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.
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