U.S. markets closed

Dividend Investors: Don't Be Too Quick To Buy Shoe Zone plc (LON:SHOE) For Its Upcoming Dividend

Simply Wall St

It looks like Shoe Zone plc (LON:SHOE) is about to go ex-dividend in the next 4 days. This means that investors who purchase shares on or after the 27th of February will not receive the dividend, which will be paid on the 18th of March.

Shoe Zone's upcoming dividend is UK£0.08 a share, following on from the last 12 months, when the company distributed a total of UK£0.12 per share to shareholders. Based on the last year's worth of payments, Shoe Zone stock has a trailing yield of around 6.1% on the current share price of £1.89. If you buy this business for its dividend, you should have an idea of whether Shoe Zone's dividend is reliable and sustainable. As a result, readers should always check whether Shoe Zone has been able to grow its dividends, or if the dividend might be cut.

View our latest analysis for Shoe Zone

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. Last year, Shoe Zone paid out 101% of its income as dividends, which is above a level that we're comfortable with, especially if the company needs to reinvest in its business. 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. Over the past year it paid out 179% of its free cash flow as dividends, which is uncomfortably 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.

Shoe Zone does have a large net cash position on the balance sheet, which could fund large dividends for a time, if the company so chose. Still, smart investors know that it is better to assess dividends relative to the cash and profit generated by the business. Paying dividends out of cash on the balance sheet is not long-term sustainable.

Cash is slightly more important than profit from a dividend perspective, but given Shoe Zone's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Click here to see how much of its profit Shoe Zone paid out over the last 12 months.

AIM:SHOE Historical Dividend Yield, February 22nd 2020

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Readers will understand then, why we're concerned to see Shoe Zone's earnings per share have dropped 6.6% a year over the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Shoe Zone has delivered an average of 26% per year annual increase in its dividend, based on the past five 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. Shoe Zone 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.

The Bottom Line

From a dividend perspective, should investors buy or avoid Shoe Zone? It's looking like an unattractive opportunity, with its earnings per share declining, while, paying out an uncomfortably high percentage of both its profits (101%) and cash flow (179%) as dividends. This is a clearly suboptimal combination that usually suggests the dividend is at risk of being cut. If not now, then perhaps in the future. Overall it doesn't look like the most suitable dividend stock for a long-term buy and hold investor.

Want to learn more about Shoe Zone? Here's a visualisation of its historical rate of revenue and earnings growth.

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.

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.

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. Thank you for reading.