U.S. Markets closed

It Might Not Be A Great Idea To Buy GR Engineering Services Limited (ASX:GNG) For Its Next 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 GR Engineering Services Limited (ASX:GNG) is about to go ex-dividend in just 3 days. This means that investors who purchase shares on or after the 10th of October will not receive the dividend, which will be paid on the 23rd of October.

GR Engineering Services's next dividend payment will be AU$0.02 per share. Last year, in total, the company distributed AU$0.04 to shareholders. Looking at the last 12 months of distributions, GR Engineering Services has a trailing yield of approximately 4.5% on its current stock price of A$0.88. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to investigate whether GR Engineering Services can afford its dividend, and if the dividend could grow.

See our latest analysis for GR Engineering Services

Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. GR Engineering Services paid out 141% 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. 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 58% of its free cash flow as dividends, within the usual range for most companies.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and GR Engineering Services fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

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

ASX:GNG Historical Dividend Yield, October 6th 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. GR Engineering Services's earnings per share have fallen at approximately 15% a year over the previous five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. GR Engineering Services has seen its dividend decline 15% per annum on average over the past eight years, which is not great to see. It's never nice to see earnings and dividends falling, but at least management has cut the dividend rather than potentially risk the company's health in an attempt to maintain it.

To Sum It Up

Is GR Engineering Services an attractive dividend stock, or better left on the shelf? Earnings per share have been shrinking in recent times. Worse, GR Engineering Services's paying out a majority of its earnings and more than half its free cash flow. Positive cash flows are good news but it's not a good combination. It's not the most attractive proposition from a dividend perspective, and we'd probably give this one a miss for now.

Curious what other investors think of GR Engineering Services? 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.