It looks like Cochlear Limited (ASX:COH) is about to go ex-dividend in the next 4 days. This means that investors who purchase shares on or after the 24th of March will not receive the dividend, which will be paid on the 17th of April.
Cochlear’s next dividend payment will be AU$1.60 per share. Last year, in total, the company distributed AU$3.30 to shareholders. Looking at the last 12 months of distributions, Cochlear has a trailing yield of approximately 1.9% on its current stock price of A$171.33. 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.
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. Cochlear paid out 63% of its earnings to investors last year, a normal payout level for most businesses. 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. Over the past year it paid out 149% of its free cash flow as dividends, which is uncomfortably 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.
Cochlear 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 Cochlear to repeatedly pay dividends that aren’t well covered by cashflow, we would consider this a warning sign.
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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. That’s why it’s comforting to see Cochlear’s earnings have been skyrocketing, up 26% per annum for the past five years. Earnings have been growing quickly, but we’re concerned dividend payments consumed most of the company’s cash flow over the past year.
The main way most investors will assess a company’s dividend prospects is by checking the historical rate of dividend growth. Cochlear has delivered an average of 5.7% per year annual increase in its dividend, based on the past ten years of dividend payments. It’s good to see both earnings and the dividend have improved – although the former has been rising much quicker than the latter, possibly due to the company reinvesting more of its profits in growth.
To Sum It Up
Should investors buy Cochlear for the upcoming dividend? Earnings per share growth is a positive, and the company’s payout ratio looks normal. However, we note Cochlear paid out a much higher percentage of its free cash flow, which makes us uncomfortable. Overall, it’s not a bad combination, but we feel that there are likely more attractive dividend prospects out there.
However if you’re still interested in Cochlear as a potential investment, you should definitely consider some of the risks involved with Cochlear. For example, Cochlear has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
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.
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