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Why It Might Not Make Sense To Buy BAE Systems plc (LON:BA.) For Its Upcoming Dividend

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 BAE Systems plc (LON:BA.) is about to go ex-dividend in just 3 days. This means that investors who purchase shares on or after the 22nd of April will not receive the dividend, which will be paid on the 1st of June.

BAE Systems's next dividend payment will be UK£0.14 per share, and in the last 12 months, the company paid a total of UK£0.23 per share. Calculating the last year's worth of payments shows that BAE Systems has a trailing yield of 4.5% on the current share price of £5.22. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. We need to see whether the dividend is covered by earnings and if it's growing.

View our latest analysis for BAE Systems

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. BAE Systems paid out more than half (58%) of its earnings last year, which is a regular payout ratio for most companies. 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 108% 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.

While BAE Systems's dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were BAE Systems 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.

historic-dividend
historic-dividend

Have Earnings And Dividends Been Growing?

Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. If earnings fall far enough, the company could be forced to cut its dividend. With that in mind, we're encouraged by the steady growth at BAE Systems, with earnings per share up 7.0% on average over the last five years. Earnings have been growing at a steady rate, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Since the start of our data, 10 years ago, BAE Systems has lifted its dividend by approximately 3.1% a year on average. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

Final Takeaway

Should investors buy BAE Systems for the upcoming dividend? BAE Systems is paying out a reasonable percentage of its income and an uncomfortably high 108% of its cash flow as dividends. At least earnings per share have been growing steadily. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of BAE Systems.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with BAE Systems. For example - BAE Systems has 1 warning sign we think you should be aware of.

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.

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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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