Watsco, Inc. (NYSE:WSO) is about to trade ex-dividend in the next 3 days. Ex-dividend means that investors that purchase the stock on or after the 14th of April will not receive this dividend, which will be paid on the 30th of April.
Watsco's next dividend payment will be US$1.78 per share, on the back of last year when the company paid a total of US$7.10 to shareholders. Looking at the last 12 months of distributions, Watsco has a trailing yield of approximately 4.4% on its current stock price of $161.48. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. We need to see whether the dividend is covered by earnings and if it's growing.
Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. Last year Watsco paid out 98% of its profits as dividends to shareholders, suggesting the dividend is not well covered by earnings. 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 76% of its free cash flow as dividends, which is within usual limits but will limit the company's ability to lift the dividend if there's no growth.
It's good to see that while Watsco's dividends were not well covered by profits, at least they are affordable from a cash perspective. Still, if the company continues paying out such a high percentage of its profits, the dividend could be at risk if business turns sour.
Have Earnings And Dividends Been Growing?
Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. With that in mind, we're encouraged by the steady growth at Watsco, with earnings per share up 8.5% on average over the last five years.
The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Since the start of our data, ten years ago, Watsco has lifted its dividend by approximately 14% 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 Watsco for the upcoming dividend? While earnings per share have been growing slowly, Watsco is paying out an uncomfortably high percentage of its earnings. However it did pay out a lower percentage of its cashflow. It's not the most attractive proposition from a dividend perspective, and we'd probably give this one a miss for now.
Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with Watsco. In terms of investment risks, we've identified 1 warning sign with Watsco and understanding them should be part of your investment process.
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.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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