Don't Buy Sonic Healthcare Limited (ASX:SHL) For Its Next Dividend Without Doing These Checks

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Sonic Healthcare Limited (ASX:SHL) is about to trade ex-dividend in the next 4 days. The ex-dividend date is two business days before a company's record date in most cases, which is the date on which the company determines which shareholders are entitled to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade can take two business days or more to settle. This means that investors who purchase Sonic Healthcare's shares on or after the 5th of March will not receive the dividend, which will be paid on the 20th of March.

The company's upcoming dividend is AU$0.44 a share, following on from the last 12 months, when the company distributed a total of AU$1.06 per share to shareholders. Last year's total dividend payments show that Sonic Healthcare has a trailing yield of 3.8% on the current share price of AU$28.03. 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 investigate whether Sonic Healthcare can afford its dividend, and if the dividend could grow.

See our latest analysis for Sonic Healthcare

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. Last year Sonic Healthcare paid out 94% of its profits as dividends to shareholders, suggesting the dividend is not well covered by earnings. 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 71% of its free cash flow as dividends, within the usual range for most companies.

It's good to see that while Sonic Healthcare's dividends were not well covered by profits, at least they are affordable from a cash perspective. Still, if this were to happen repeatedly, we'd be concerned about whether the dividend is sustainable in a downturn.

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

Have Earnings And Dividends Been Growing?

Stocks with flat earnings can still be attractive dividend payers, but it is important to be more conservative with your approach and demand a greater margin for safety when it comes to dividend sustainability. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're not enthused to see that Sonic Healthcare's earnings per share have remained effectively flat over the past five years. Better than seeing them fall off a cliff, for sure, but the best dividend stocks grow their earnings meaningfully over the long run.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Sonic Healthcare has delivered 4.7% dividend growth per year on average over the past 10 years.

To Sum It Up

Should investors buy Sonic Healthcare for the upcoming dividend? Earnings per share have been flat in recent times, which is, we suppose, better than seeing them shrink. Additionally, Sonic Healthcare is paying out quite a high percentage of its earnings, and more than half its cash flow, so it's hard to evaluate whether the company is reinvesting enough in its business to improve its situation. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

With that being said, if you're still considering Sonic Healthcare as an investment, you'll find it beneficial to know what risks this stock is facing. In terms of investment risks, we've identified 1 warning sign with Sonic Healthcare and understanding them should be part of your investment process.

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.