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

CAR Group Limited (ASX:CAR) stock is about to trade ex-dividend in 4 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 important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. This means that investors who purchase CAR Group's shares on or after the 13th of September will not receive the dividend, which will be paid on the 14th of October.

The company's upcoming dividend is AU$0.385 a share, following on from the last 12 months, when the company distributed a total of AU$0.77 per share to shareholders. Last year's total dividend payments show that CAR Group has a trailing yield of 2.1% on the current share price of AU$36.84. If you buy this business for its dividend, you should have an idea of whether CAR Group's dividend is reliable and sustainable. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

See our latest analysis for CAR Group

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. CAR Group distributed an unsustainably high 110% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. Dividends consumed 69% of the company's free cash flow last year, which is within a normal range for most dividend-paying organisations.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and CAR Group fortunately did generate enough cash to fund its dividend. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

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

Have Earnings And Dividends Been Growing?

Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. With that in mind, we're encouraged by the steady growth at CAR Group, with earnings per share up 4.1% on average over the last five years.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. CAR Group has delivered an average of 9.1% per year annual increase in its dividend, based on the past 10 years of dividend payments. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

The Bottom Line

From a dividend perspective, should investors buy or avoid CAR Group? While earnings per share have been growing slowly, CAR Group is paying out an uncomfortably high percentage of its earnings. However it did pay out a lower percentage of its cashflow. Overall it doesn't look like the most suitable dividend stock for a long-term buy and hold investor.

With that being said, if you're still considering CAR Group as an investment, you'll find it beneficial to know what risks this stock is facing. For example - CAR Group has 2 warning signs we think you should be aware of.

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.