Cochlear Limited (ASX:COH) is about to trade ex-dividend in the next 4 days. This means that investors who purchase shares on or after the 24th of March will not receive the dividend, which will be paid on the 17th of April.
Cochlear's next dividend payment will be AU$1.60 per share. Last year, in total, the company distributed AU$3.30 to shareholders. Looking at the last 12 months of distributions, Cochlear has a trailing yield of approximately 1.9% on its current stock price of A$171.33. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.
If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Cochlear paid out 63% of its earnings to investors last year, a normal payout level for most businesses. 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. Cochlear paid out more free cash flow than it generated - 149%, to be precise - last year, which we think is concerningly 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.
While Cochlear's dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Cochlear to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.
Have Earnings And Dividends Been Growing?
Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. That's why it's comforting to see Cochlear's earnings have been skyrocketing, up 26% per annum for the past five years. Earnings have been growing quickly, but we're concerned dividend payments consumed most of the company's cash flow over the past year.
The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the last ten years, Cochlear has lifted its dividend by approximately 5.7% a year on average. It's good to see both earnings and the dividend have improved - although the former has been rising much quicker than the latter, possibly due to the company reinvesting more of its profits in growth.
To Sum It Up
Has Cochlear got what it takes to maintain its dividend payments? Earnings per share growth is a positive, and the company's payout ratio looks normal. However, we note Cochlear paid out a much higher percentage of its free cash flow, which makes us uncomfortable. In summary, it's hard to get excited about Cochlear from a dividend perspective.
If you're not too concerned about Cochlear's ability to pay dividends, you should still be mindful of some of the other risks that this business faces. For example, we've found 2 warning signs for Cochlear (1 is potentially serious!) that deserve your attention before investing in the shares.
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.
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