Do These 3 Checks Before Buying Challenger Limited (ASX:CGF) For Its Upcoming Dividend

It looks like Challenger Limited (ASX:CGF) is about to go ex-dividend in the next 3 days. The ex-dividend date is one business day before the record date, which is the cut-off date for shareholders to be present on the company's books to be eligible for a dividend payment. 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. Meaning, you will need to purchase Challenger's shares before the 21st of February to receive the dividend, which will be paid on the 21st of March.

The company's upcoming dividend is AU$0.12 a share, following on from the last 12 months, when the company distributed a total of AU$0.24 per share to shareholders. Based on the last year's worth of payments, Challenger stock has a trailing yield of around 3.2% on the current share price of A$7.39. 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.

View our latest analysis for Challenger

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. Challenger distributed an unsustainably high 167% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious.

When the dividend payout ratio is high, as it is in this case, the dividend is usually at greater risk of being cut in the future.

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

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Readers will understand then, why we're concerned to see Challenger's earnings per share have dropped 28% a year over the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Since the start of our data, 10 years ago, Challenger has lifted its dividend by approximately 3.5% 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. Challenger 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.

To Sum It Up

Should investors buy Challenger for the upcoming dividend? Earnings per share are in decline and Challenger is paying out what we feel is an uncomfortably 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. Challenger doesn't appear to have a lot going for it, and we're not inclined to take a risk on owning it for the dividend.

Although, if you're still interested in Challenger and want to know more, you'll find it very useful to know what risks this stock faces. Case in point: We've spotted 2 warning signs for Challenger you should be aware of.

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

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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.