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It Might Not Be A Great Idea To Buy Smiths Group plc (LON:SMIN) For Its Next Dividend

Simply Wall St

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Smiths Group plc (LON:SMIN) is about to trade ex-dividend in the next 3 days. If you purchase the stock on or after the 17th of October, you won't be eligible to receive this dividend, when it is paid on the 15th of November.

Smiths Group's next dividend payment will be UK£0.3 per share, and in the last 12 months, the company paid a total of UK£0.5 per share. Based on the last year's worth of payments, Smiths Group has a trailing yield of 2.9% on the current stock price of £15.775. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. As a result, readers should always check whether Smiths Group has been able to grow its dividends, or if the dividend might be cut.

View our latest analysis for Smiths Group

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Smiths Group distributed an unsustainably high 130% of its profit as dividends to shareholders last year. Without extenuating circumstances, we'd consider the dividend at risk of a cut. 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. Over the last year, it paid out more than three-quarters (78%) of its free cash flow generated, which is fairly high and may be starting to limit reinvestment in the business.

It's good to see that while Smiths Group's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

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

LSE:SMIN Historical Dividend Yield, October 13th 2019

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If earnings fall far enough, the company could be forced to cut its dividend. With that in mind, we're discomforted by Smiths Group's 9.8% per annum decline in earnings in the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the last ten years, Smiths Group has lifted its dividend by approximately 3.0% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. Smiths Group is already paying out 130% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

To Sum It Up

Is Smiths Group an attractive dividend stock, or better left on the shelf? It's never fun to see a company's earnings per share in retreat. Additionally, Smiths Group is paying out quite a high percentage of its earnings, and more than half its cash flow, so it's hard to evaluate whether the company is reinvesting enough in its business to improve its situation. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Smiths Group.

Wondering what the future holds for Smiths Group? See what the 12 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.