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Here's Why We're Wary Of Buying Zytronic plc's (LON:ZYT) For Its Upcoming Dividend

Simply Wall St

Readers hoping to buy Zytronic plc (LON:ZYT) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. If you purchase the stock on or after the 9th of January, you won't be eligible to receive this dividend, when it is paid on the 7th of February.

Zytronic's upcoming dividend is UK£0.15 a share, following on from the last 12 months, when the company distributed a total of UK£0.23 per share to shareholders. Based on the last year's worth of payments, Zytronic has a trailing yield of 9.4% on the current stock price of £2.425. 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.

See our latest analysis for Zytronic

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Zytronic distributed an unsustainably high 136% of its profit as dividends to shareholders last year. Without extenuating circumstances, we'd consider the dividend at risk of a cut. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. Over the past year it paid out 174% of its free cash flow as dividends, which is uncomfortably high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.

Zytronic 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 Zytronic'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 Zytronic paid out over the last 12 months.

AIM:ZYT Historical Dividend Yield, January 5th 2020

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. So we're not too excited that Zytronic's earnings are down 3.1% a year over the past five years.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the last ten years, Zytronic has lifted its dividend by approximately 16% a year on average. 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. Zytronic 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 Zytronic? Not only are earnings per share declining, but Zytronic is paying out an uncomfortably high percentage of both its earnings and cashflow to shareholders as dividends. This is a starkly negative combination that often suggests a dividend cut could be in the company's near future. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Zytronic.

Keen to explore more data on Zytronic's financial performance? Check out our visualisation of its historical revenue and earnings growth.

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.

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.