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Do These 3 Checks Before Buying Elementis plc (LON:ELM) For Its Upcoming Dividend

Simply Wall St

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Elementis plc (LON:ELM) is about to trade ex-dividend in the next 3 days. If you purchase the stock on or after the 5th of September, you won't be eligible to receive this dividend, when it is paid on the 27th of September.

Elementis's next dividend payment will be US$0.022 per share, and in the last 12 months, the company paid a total of US$0.086 per share. Last year's total dividend payments show that Elementis has a trailing yield of 4.7% on the current share price of £1.499. If you buy this business for its dividend, you should have an idea of whether Elementis's dividend is reliable and sustainable. So we need to check whether the dividend payments are covered, and if earnings are growing.

View our latest analysis for Elementis

Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. It paid out 83% of its earnings as dividends last year, which is not unreasonable, but limits reinvestment in the business and leaves the dividend vulnerable to a business downturn. We'd be worried about the risk of a drop in earnings. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. Elementis paid out more free cash flow than it generated - 116%, to be precise - last year, which we think is concerningly high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Elementis paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Were this to happen repeatedly, this would be a risk to Elementis's ability to maintain its dividend.

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

LSE:ELM Historical Dividend Yield, September 1st 2019

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. If earnings fall far enough, the company could be forced to cut its dividend. Readers will understand then, why we're concerned to see Elementis's earnings per share have dropped 15% a year over the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

We'd also point out that Elementis issued a meaningful number of new shares in the past year. Trying to grow the dividend while issuing large amounts of new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Elementis has delivered an average of 8.1% per year annual increase in its dividend, based on the past 10 years of dividend payments. 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. Elementis 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.

Final Takeaway

From a dividend perspective, should investors buy or avoid Elementis? Elementis had an average payout ratio, but its free cash flow was lower and earnings per share have been declining. It's not the most attractive proposition from a dividend perspective, and we'd probably give this one a miss for now.

Wondering what the future holds for Elementis? See what the nine analysts we track are forecasting, with this visualisation of its historical and future estimated earnings and cash flow

A common investment mistake is buying the first interesting stock you see. Here you can find a list of promising dividend stocks with a greater than 2% yield and an upcoming dividend.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.