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It Might Be Better To Avoid Think Childcare Limited's (ASX:TNK) Upcoming 1.5% Dividend

Simply Wall St

Readers hoping to buy Think Childcare Limited (ASX:TNK) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. Ex-dividend means that investors that purchase the stock on or after the 5th of September will not receive this dividend, which will be paid on the 20th of September.

Think Childcare's upcoming dividend is AU$0.02 a share, following on from the last 12 months, when the company distributed a total of AU$0.04 per share to shareholders. Based on the last year's worth of payments, Think Childcare has a trailing yield of 3.1% on the current stock price of A$1.3. If you buy this business for its dividend, you should have an idea of whether Think Childcare's dividend is reliable and sustainable. So we need to investigate whether Think Childcare can afford its dividend, and if the dividend could grow.

Check out our latest analysis for Think Childcare

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. Think Childcare paid out 115% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance. 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. Think Childcare paid out more free cash flow than it generated - 128%, to be precise - last year, which we think is concerningly high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Cash is slightly more important than profit from a dividend perspective, but given Think Childcare's payouts were not well covered by either earnings or cash flow, we would be concerned about the sustainability of this dividend.

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

ASX:TNK Historical Dividend Yield, September 1st 2019

Have Earnings And Dividends Been Growing?

Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. It's encouraging to see Think Childcare has grown its earnings rapidly, up 30% a year for the past five years. Think Childcare's dividend was not well covered by earnings, although at least its earnings per share are growing quickly. Fast-growing businesses normally need to reinvest most of their earnings in order to maintain growth, so we'd suspect that either earnings growth will slow or the dividend may not be increased for a while.

Think Childcare 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.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. Think Childcare has seen its dividend decline 14% per annum on average over the past 4 years, which is not great to see. Think Childcare is a rare case where dividends have been decreasing at the same time as earnings per share have been improving. It's unusual to see, and could point to unstable conditions in the core business, or more rarely an intensified focus on reinvesting profits.

The Bottom Line

Is Think Childcare an attractive dividend stock, or better left on the shelf? While it's nice to see earnings per share growing, we're curious about how Think Childcare intends to continue growing, or maintain the dividend in a downturn given that it's paying out such a high percentage of its earnings and cashflow. Overall it doesn't look like the most suitable dividend stock for a long-term buy and hold investor.

Curious what other investors think of Think Childcare? See what analysts 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.