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Why It Might Not Make Sense To Buy Ricardo plc (LON:RCDO) For Its Upcoming Dividend

Simply Wall St

Readers hoping to buy Ricardo plc (LON:RCDO) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. This means that investors who purchase shares on or after the 7th of November will not receive the dividend, which will be paid on the 21st of November.

Ricardo's next dividend payment will be UK£0.2 per share. Last year, in total, the company distributed UK£0.2 to shareholders. Last year's total dividend payments show that Ricardo has a trailing yield of 3.2% on the current share price of £6.6. 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 Ricardo has been able to grow its dividends, or if the dividend might be cut.

Check out our latest analysis for Ricardo

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. Ricardo paid out 57% of its earnings to investors last year, a normal payout level for most businesses. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. Ricardo paid out more free cash flow than it generated - 129%, to be precise - last year, which we think is concerningly high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Ricardo paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Ricardo 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.

LSE:RCDO Historical Dividend Yield, November 3rd 2019

Have Earnings And Dividends Been Growing?

Companies that aren't growing their earnings can still be valuable, but it is even more important to assess the sustainability of the dividend if it looks like the company will struggle to grow. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. It's not encouraging to see that Ricardo's earnings are effectively flat over the past five years. Better than seeing them fall off a cliff, for sure, but the best dividend stocks grow their earnings meaningfully over the long run. Earnings have been growing somewhat, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Ricardo has delivered an average of 7.1% per year annual increase in its dividend, based on the past ten years of dividend payments.

Final Takeaway

Is Ricardo an attractive dividend stock, or better left on the shelf? In addition to earnings being flat, Ricardo is paying out a reasonable percentage of its earnings as profits. However, the dividend was not well covered by free cash flow. It's not the most attractive proposition from a dividend perspective, and we'd probably give this one a miss for now.

Ever wonder what the future holds for Ricardo? See what the seven analysts we track are forecasting, with this visualisation of its historical and future estimated earnings and cash flow

A common investment mistake is buying the first interesting stock you see. Here you can find a list of promising 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.