It Might Not Be A Great Idea To Buy Domtar Corporation (NYSE:UFS) For Its Next Dividend

Domtar Corporation (NYSE:UFS) stock is about to trade ex-dividend in 4 days time. This means that investors who purchase shares on or after the 1st of April will not receive the dividend, which will be paid on the 15th of April.

Domtar’s next dividend payment will be US$0.46 per share, on the back of last year when the company paid a total of US$1.82 to shareholders. Calculating the last year’s worth of payments shows that Domtar has a trailing yield of 8.2% on the current share price of $22.1. If you buy this business for its dividend, you should have an idea of whether Domtar’s dividend is reliable and sustainable. As a result, readers should always check whether Domtar has been able to grow its dividends, or if the dividend might be cut.

Check out our latest analysis for Domtar

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. Domtar distributed an unsustainably high 133% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. 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 59% of its free cash flow as dividends, within the usual range for most companies.

It’s good to see that while Domtar’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. Very few companies are able to sustainably pay dividends larger than their reported earnings.

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

NYSE:UFS Historical Dividend Yield March 27th 2020
NYSE:UFS Historical Dividend Yield March 27th 2020

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If earnings fall far enough, the company could be forced to cut its dividend. With that in mind, we’re discomforted by Domtar’s 27% 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.

The main way most investors will assess a company’s dividend prospects is by checking the historical rate of dividend growth. In the past ten years, Domtar has increased its dividend at approximately 14% a year on average. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Domtar is already paying out a high percentage of its income, so without earnings growth, we’re doubtful of whether this dividend will grow much in the future.

Final Takeaway

From a dividend perspective, should investors buy or avoid Domtar? Earnings per share have been shrinking in recent times. Worse, Domtar’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. Overall it doesn’t look like the most suitable dividend stock for a long-term buy and hold investor.

With that in mind though, if the poor dividend characteristics of Domtar don’t faze you, it’s worth being mindful of the risks involved with this business. Case in point: We’ve spotted 4 warning signs for Domtar you should be aware of.

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.

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.

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