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Should Income Investors Look At Paychex, Inc. (NASDAQ:PAYX) Before Its Ex-Dividend?

Simply Wall St

Some investors rely on dividends for growing their wealth, and if you're one of those dividend sleuths, you might be intrigued to know that Paychex, Inc. (NASDAQ:PAYX) is about to go ex-dividend in just 4 days. Ex-dividend means that investors that purchase the stock on or after the 31st of July will not receive this dividend, which will be paid on the 22nd of August.

Paychex's upcoming dividend is US$0.62 a share, following on from the last 12 months, when the company distributed a total of US$2.48 per share to shareholders. Last year's total dividend payments show that Paychex has a trailing yield of 2.9% on the current share price of $85.42. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

Check out our latest analysis for Paychex

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Its dividend payout ratio is 78% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth It could become a concern if earnings started to decline. 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 71% of its free cash flow as dividends, within the usual range for most companies.

It's positive to see that Paychex's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

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

NasdaqGS:PAYX Historical Dividend Yield, July 26th 2019

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. Fortunately for readers, Paychex's earnings per share have been growing at 11% a year for the past five years. The company paid out most of its earnings as dividends over the last year, even though business is booming and earnings per share are growing rapidly. Higher earnings generally bode well for growing dividends, although with seemingly strong growth prospects we'd wonder why management are not reinvesting more in the business.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the past 10 years, Paychex has increased its dividend at approximately 7.2% a year on average. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

The Bottom Line

Is Paychex worth buying for its dividend? It's good to see earnings are growing, since all of the best dividend stocks grow their earnings meaningfully over the long run. However, we'd also note that Paychex is paying out more than half of its earnings and cash flow as profits, which could limit the dividend growth if earnings growth slows. It might be worth researching if the company is reinvesting in growth projects that could grow earnings and dividends in the future, but for now we're not all that optimistic on its dividend prospects.

Ever wonder what the future holds for Paychex? See what the 17 analysts we track are forecasting, with this visualisation of its historical and future estimated earnings and cash flow

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.

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.