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Why It Might Not Make Sense To Buy American Software, Inc. (NASDAQ:AMSW.A) For Its Upcoming Dividend

Simply Wall St

American Software, Inc. (NASDAQ:AMSW.A) is about to trade ex-dividend in the next 4 days. You will need to purchase shares before the 15th of August to receive the dividend, which will be paid on the 30th of August.

American Software's next dividend payment will be US$0.11 per share. Last year, in total, the company distributed US$0.44 to shareholders. Based on the last year's worth of payments, American Software has a trailing yield of 3.3% on the current stock price of $13.49. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

Check out our latest analysis for American Software

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. American Software paid out a disturbingly high 200% of its profit as dividends last year, which makes us concerned there's something we don't fully understand in the business. A useful secondary check can be to evaluate whether American Software generated enough free cash flow to afford its dividend. Over the last year, it paid out more than three-quarters (81%) of its free cash flow generated, which is fairly high and may be starting to limit reinvestment in the business.

It's good to see that while American Software's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

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

NasdaqGS:AMSW.A Historical Dividend Yield, August 10th 2019

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. With that in mind, we're discomforted by American Software's 10% per annum decline in earnings in the past 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. In the past 10 years, American Software has increased its dividend at approximately 2.0% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. American Software is already paying out 200% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

Is American Software an attractive dividend stock, or better left on the shelf? It's never fun to see a company's earnings per share in retreat. Worse, American Software'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 an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Wondering what the future holds for American Software? See what the two 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.