Here's Why We're Wary Of Buying Solvar's (ASX:SVR) For Its Upcoming Dividend

It looks like Solvar Limited (ASX:SVR) is about to go ex-dividend in the next 2 days. Typically, the ex-dividend date is two business days before the record date, which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. Thus, you can purchase Solvar's shares before the 4th of March in order to receive the dividend, which the company will pay on the 3rd of April.

The company's next dividend payment will be AU$0.06 per share, on the back of last year when the company paid a total of AU$0.10 to shareholders. Looking at the last 12 months of distributions, Solvar has a trailing yield of approximately 7.1% on its current stock price of AU$1.41. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. We need to see whether the dividend is covered by earnings and if it's growing.

See our latest analysis for Solvar

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. Solvar paid out 123% 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.

Generally, the higher a company's payout ratio, the more the dividend is at risk of being reduced.

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. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. So we're not too excited that Solvar's earnings are down 4.7% a year over the past five years.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Solvar has delivered an average of 8.3% per year annual increase in its dividend, based on the past 10 years of dividend payments. 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. Solvar is already paying out 123% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

Is Solvar worth buying for its dividend? Earnings per share are in decline and Solvar 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. 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.

With that in mind though, if the poor dividend characteristics of Solvar don't faze you, it's worth being mindful of the risks involved with this business. To that end, you should learn about the 4 warning signs we've spotted with Solvar (including 2 which are significant).

Generally, we wouldn't recommend just buying the first dividend stock you see. Here's a curated list of interesting stocks that are strong dividend payers.

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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.