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Why It Might Not Make Sense To Buy Vital Limited (NZSE:VTL) For Its Upcoming Dividend

Simply Wall St
·4 mins read

It looks like Vital Limited (NZSE:VTL) is about to go ex-dividend in the next four days. If you purchase the stock on or after the 1st of October, you won't be eligible to receive this dividend, when it is paid on the 16th of October.

The upcoming dividend for Vital is NZ$0.029 per share, increased from last year's total dividends per share of NZ$0.025. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether Vital can afford its dividend, and if the dividend could grow.

See our latest analysis for Vital

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. Vital distributed an unsustainably high 141% of its profit as dividends to shareholders last year. Without extenuating circumstances, we'd consider the dividend at risk of a cut. A useful secondary check can be to evaluate whether Vital generated enough free cash flow to afford its dividend. What's good is that dividends were well covered by free cash flow, with the company paying out 22% of its cash flow last year.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Vital fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Click here to see how much of its profit Vital paid out over the last 12 months.

historic-dividend
historic-dividend

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're discomforted by Vital's 18% 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. Vital has seen its dividend decline 19% per annum on average over the past 10 years, which is not great to see. It's never nice to see earnings and dividends falling, but at least management has cut the dividend rather than potentially risk the company's health in an attempt to maintain it.

The Bottom Line

From a dividend perspective, should investors buy or avoid Vital? It's never great to see earnings per share declining, especially when a company is paying out 141% of its profit as dividends, which we feel is uncomfortably high. However, the cash payout ratio was much lower - good news from a dividend perspective - which makes us wonder why there is such a mis-match between income and cashflow. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Vital.

With that being said, if you're still considering Vital as an investment, you'll find it beneficial to know what risks this stock is facing. Case in point: We've spotted 3 warning signs for Vital 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@simplywallst.com.