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Here's Why We're Wary Of Buying Surge Energy Inc.'s (TSE:SGY) For Its Upcoming Dividend

Simply Wall St

Surge Energy Inc. (TSE:SGY) stock is about to trade ex-dividend in 4 days time. If you purchase the stock on or after the 29th of August, you won't be eligible to receive this dividend, when it is paid on the 16th of September.

Surge Energy's upcoming dividend is CA$0.0083 a share, following on from the last 12 months, when the company distributed a total of CA$0.10 per share to shareholders. Last year's total dividend payments show that Surge Energy has a trailing yield of 9.2% on the current share price of CA$1.09. 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 investigate whether Surge Energy can afford its dividend, and if the dividend could grow.

Check out our latest analysis for Surge Energy

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. Surge Energy reported a loss after tax last year, which means it's paying a dividend despite being unprofitable. While this might be a one-off event, this is unlikely to be sustainable in the long term. Considering the lack of profitability, we also need to check if the company generated enough cash flow to cover the dividend payment. If cash earnings don't cover the dividend, the company would have to pay dividends out of cash in the bank, or by borrowing money, neither of which is long-term sustainable. Over the last year, it paid out dividends equivalent to 287% of what it generated in free cash flow, a disturbingly high percentage. Unless there were something in the business we're not grasping, this could signal a risk that the dividend may have to be cut in the future.

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

TSX:SGY Historical Dividend Yield, August 24th 2019

Have Earnings And Dividends Been Growing?

Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Surge Energy was unprofitable last year, but at least the general trend suggests its earnings have been improving over the past five years. Even so, an unprofitable company whose business does not quickly recover is usually not a good candidate for dividend investors.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Surge Energy has seen its dividend decline 21% per annum on average over the past 6 years, which is not great to see.

Get our latest analysis on Surge Energy's balance sheet health here.

To Sum It Up

From a dividend perspective, should investors buy or avoid Surge Energy? We're a bit uncomfortable with it paying a dividend while being loss-making, especially given that the dividend was not well covered by free cash flow. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Ever wonder what the future holds for Surge Energy? See what the five analysts we track are forecasting, with this visualisation of its historical and future estimated earnings and cash flow

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.

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.