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It Might Not Be A Great Idea To Buy Rocky Mountain Dealerships Inc. (TSE:RME) For Its Next Dividend

Simply Wall St

Readers hoping to buy Rocky Mountain Dealerships Inc. (TSE:RME) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. You can purchase shares before the 12th of September in order to receive the dividend, which the company will pay on the 30th of September.

Rocky Mountain Dealerships's next dividend payment will be CA$0.12 per share, on the back of last year when the company paid a total of CA$0.49 to shareholders. Last year's total dividend payments show that Rocky Mountain Dealerships has a trailing yield of 7.1% on the current share price of CA$6.9. If you buy this business for its dividend, you should have an idea of whether Rocky Mountain Dealerships's dividend is reliable and sustainable. We need to see whether the dividend is covered by earnings and if it's growing.

View our latest analysis for Rocky Mountain Dealerships

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. Rocky Mountain Dealerships paid out 95% of its earnings, which is more than we're comfortable with, unless there are mitigating circumstances. A useful secondary check can be to evaluate whether Rocky Mountain Dealerships generated enough free cash flow to afford its dividend. Fortunately, it paid out only 33% of its free cash flow in the past year.

It's good to see that while Rocky Mountain Dealerships's dividends were not well covered by profits, at least they are affordable from a cash perspective. Still, if this were to happen repeatedly, we'd be concerned about whether the dividend is sustainable in a downturn.

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

TSX:RME Historical Dividend Yield, September 7th 2019

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. Rocky Mountain Dealerships's earnings per share have fallen at approximately 8.4% a year over the previous 5 years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the last 10 years, Rocky Mountain Dealerships has lifted its dividend by approximately 11% a year on average. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Rocky Mountain Dealerships is already paying out 95% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

Final Takeaway

From a dividend perspective, should investors buy or avoid Rocky Mountain Dealerships? It's not a great combination to see a company with earnings in decline and paying out 95% of its profits, which could imply the dividend may be at risk of being cut in the future. However, the cash payout ratio was much lower - good news from a dividend perspective - which makes us wonder why there is such a mis-match between income and cashflow. Bottom line: Rocky Mountain Dealerships has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

Wondering what the future holds for Rocky Mountain Dealerships? See what the five 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.