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Don't Buy Domtar Corporation (NYSE:UFS) For Its Next Dividend Without Doing These Checks

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Simply Wall St
·4 min read
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Domtar Corporation (NYSE:UFS) stock is about to trade ex-dividend in 4 days time. This means that investors who purchase shares on or after the 1st of April will not receive the dividend, which will be paid on the 15th of April.

Domtar's next dividend payment will be US$0.46 per share. Last year, in total, the company distributed US$1.82 to shareholders. Looking at the last 12 months of distributions, Domtar has a trailing yield of approximately 8.2% on its current stock price of $22.1. We love seeing companies pay a dividend, but it's also important to be sure that laying the golden eggs isn't going to kill our golden goose! So we need to check whether the dividend payments are covered, and if earnings are growing.

Check out our latest analysis for Domtar

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Domtar paid out 133% 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. 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 last year it paid out 59% of its free cash flow as dividends, within the usual range for most companies.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Domtar fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

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

NYSE:UFS Historical Dividend Yield March 27th 2020
NYSE:UFS Historical Dividend Yield March 27th 2020

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If earnings fall far enough, the company could be forced to cut its dividend. Readers will understand then, why we're concerned to see Domtar's earnings per share have dropped 27% a year over the past five years. Such a sharp decline casts doubt on the future sustainability of the dividend.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Domtar has delivered 14% dividend growth per year on average over the past ten years. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. Domtar 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

Should investors buy Domtar for the upcoming dividend? Earnings per share have been shrinking in recent times. Worse, Domtar's paying out a majority of its earnings and more than half its free cash flow. Positive cash flows are good news but it's not a good combination. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with Domtar. For example - Domtar has 4 warning signs we think you should be aware of.

We wouldn't recommend just buying the first dividend stock you see, though. Here's a list of interesting 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.