Dividend Investors: Don't Be Too Quick To Buy Australian Foundation Investment Company Limited (ASX:AFI) For Its Upcoming Dividend

Australian Foundation Investment Company Limited (ASX:AFI) stock is about to trade ex-dividend in four days. The ex-dividend date is one business day before a company's record date, which is the date on which the company determines which shareholders are entitled to receive a dividend. The ex-dividend date is an important date to be aware of as any purchase of the stock made on or after this date might mean a late settlement that doesn't show on the record date. Thus, you can purchase Australian Foundation Investment's shares before the 3rd of February in order to receive the dividend, which the company will pay on the 25th of February.

The company's next dividend payment will be AU$0.12 per share. Last year, in total, the company distributed AU$0.26 to shareholders. Last year's total dividend payments show that Australian Foundation Investment has a trailing yield of 3.4% on the current share price of AU$7.60. 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 check whether the dividend payments are covered, and if earnings are growing.

View our latest analysis for Australian Foundation Investment

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. Australian Foundation Investment paid out 110% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance.

When a company pays out a dividend that is not well covered by profits, the dividend is generally seen as more vulnerable to being cut.

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

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. Australian Foundation Investment's earnings per share have fallen at approximately 6.8% a year over the previous 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 last 10 years, Australian Foundation Investment has lifted its dividend by approximately 1.7% a year on average.

The Bottom Line

Has Australian Foundation Investment got what it takes to maintain its dividend payments? Not only are earnings per share shrinking, but Australian Foundation Investment is paying out a disconcertingly high percentage of its profit as dividends. Generally we think dividend investors should avoid businesses in this situation, as high payout ratios and declining earnings can lead to the dividend being cut. These characteristics don't generally lead to outstanding dividend performance, and investors may not be happy with the results of owning this stock for its dividend.

So if you're still interested in Australian Foundation Investment despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. Case in point: We've spotted 1 warning sign for Australian Foundation Investment you should be aware of.

If you're in the market for strong dividend payers, we recommend checking our selection of top dividend stocks.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.