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Why It Might Not Make Sense To Buy Diversified Royalty Corp. (TSE:DIV) For Its Upcoming Dividend

Simply Wall St

Diversified Royalty Corp. (TSE:DIV) is about to trade ex-dividend in the next 3 days. You will need to purchase shares before the 14th of August to receive the dividend, which will be paid on the 30th of August.

Diversified Royalty's upcoming dividend is CA$0.019 a share, following on from the last 12 months, when the company distributed a total of CA$0.22 per share to shareholders. Calculating the last year's worth of payments shows that Diversified Royalty has a trailing yield of 7.7% on the current share price of CA$2.88. If you buy this business for its dividend, you should have an idea of whether Diversified Royalty's dividend is reliable and sustainable. We need to see whether the dividend is covered by earnings and if it's growing.

View our latest analysis for Diversified Royalty

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. Last year, Diversified Royalty paid out 240% of its profit to shareholders in the form of dividends. This is not sustainable behaviour and requires a closer look on behalf of the purchaser. 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. Over the last year, it paid out dividends equivalent to 314% of what it generated in free cash flow, a disturbingly high percentage. It's pretty hard to pay out more than you earn, so we wonder how Diversified Royalty intends to continue funding this dividend, or if it could be forced to the payment.

As Diversified Royalty's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

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

TSX:DIV Historical Dividend Yield, August 10th 2019

Have Earnings And Dividends Been Growing?

Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. If earnings fall far enough, the company could be forced to cut its dividend. For this reason, we're glad to see Diversified Royalty's earnings per share have risen 12% per annum over the last five years. Earnings are growing pretty quickly, which is great, but it's uncomfortably to see the company paying out 240% of earnings. We're wary of fast-growing companies flaming out by over-committing themselves financially, and consider this a yellow flag.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the last 5 years, Diversified Royalty has lifted its dividend by approximately 3.4% a year on average. Earnings per share have been growing much quicker than dividends, potentially because Diversified Royalty is keeping back more of its profits to grow the business.

To Sum It Up

Is Diversified Royalty an attractive dividend stock, or better left on the shelf? While it's nice to see earnings per share growing, we're curious about how Diversified Royalty intends to continue growing, or maintain the dividend in a downturn given that it's paying out such a high percentage of its earnings and cashflow. 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 Diversified Royalty? See what analysts 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.