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It Might Be Better To Avoid Downer EDI Limited's (ASX:DOW) Upcoming 1.8% Dividend

Simply Wall St

It looks like Downer EDI Limited (ASX:DOW) is about to go ex-dividend in the next 4 days. This means that investors who purchase shares on or after the 3rd of September will not receive the dividend, which will be paid on the 2nd of October.

Downer EDI's next dividend payment will be AU$0.14 per share, and in the last 12 months, the company paid a total of AU$0.28 per share. Looking at the last 12 months of distributions, Downer EDI has a trailing yield of approximately 3.7% on its current stock price of A$7.61. 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! That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

See our latest analysis for Downer EDI

Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. Downer EDI paid out 65% of its earnings to investors last year, a normal payout level for most businesses. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. The company paid out 94% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Companies usually need cash more than they need earnings - expenses don't pay themselves - so it's not great to see it paying out so much of its cash flow.

Downer EDI paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Downer EDI to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

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

ASX:DOW Historical Dividend Yield, August 29th 2019

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. That's why it's not ideal to see Downer EDI's earnings per share have been shrinking at 2.4% a year over the previous five years.

Downer EDI also issued more than 5% of its market cap in new stock during the past year, which we feel is likely to hurt its dividend prospects in the long run. Trying to grow the dividend while issuing large amounts of new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the past 10 years, Downer EDI has increased its dividend at approximately 0.9% a year on average.

Final Takeaway

Is Downer EDI worth buying for its dividend? It's definitely not great to see earnings per share shrinking. The company paid out an acceptable percentage of its income, but an uncomfortably high percentage of its cash flow over the past year. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Downer EDI.

Curious what other investors think of Downer EDI? See what analysts 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.