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Why It Might Not Make Sense To Buy Telecom Plus PLC (LON:TEP) For Its Upcoming Dividend

Telecom Plus PLC (LON:TEP) is about to trade ex-dividend in the next 2 days. You can purchase shares before the 28th of November in order to receive the dividend, which the company will pay on the 13th of December.

Telecom Plus's next dividend payment will be UK£0.27 per share, and in the last 12 months, the company paid a total of UK£0.52 per share. Based on the last year's worth of payments, Telecom Plus stock has a trailing yield of around 3.9% on the current share price of £13.28. If you buy this business for its dividend, you should have an idea of whether Telecom Plus's dividend is reliable and sustainable. We need to see whether the dividend is covered by earnings and if it's growing.

Check out our latest analysis for Telecom Plus

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. Telecom Plus paid out 125% 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. It paid out an unsustainably high 212% of its free cash flow as dividends over the past 12 months, which is worrying. Unless there were something in the business we're not grasping, this could signal a risk that the dividend may have to be cut in the future.

Cash is slightly more important than profit from a dividend perspective, but given Telecom Plus's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

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

LSE:TEP Historical Dividend Yield, November 25th 2019
LSE:TEP Historical Dividend Yield, November 25th 2019

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 business enters a downturn and the dividend is cut, the company could see its value fall precipitously. This is why it's a relief to see Telecom Plus earnings per share are up 2.8% per annum over the last five years. With limited earnings growth and paying out a concerningly high percentage of its earnings, the prospects of future dividend growth don't look so bright here.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the past ten years, Telecom Plus has increased its dividend at approximately 12% a year on average. We're glad to see dividends rising alongside earnings over a number of years, which may be a sign the company intends to share the growth with shareholders.

To Sum It Up

Should investors buy Telecom Plus for the upcoming dividend? Telecom Plus is paying out an uncomfortably high percentage of both earnings and cash flow as dividends, although at least earnings per share are growing somewhat. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Telecom Plus.

Wondering what the future holds for Telecom Plus? 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.

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.

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. Thank you for reading.