Readers hoping to buy McGrath Limited (ASX:MEA) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. 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 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 McGrath's shares before the 28th of February in order to receive the dividend, which the company will pay on the 23rd of March.
The company's next dividend payment will be AU$0.025 per share, which looks like a nice increase on last year, when the company distributed a total of AU$0.02 to shareholders. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. As a result, readers should always check whether McGrath has been able to grow its dividends, or if the dividend might be cut.
If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. McGrath has a low and conservative payout ratio of just 19% of its income after tax. 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. The good news is it paid out just 9.5% of its free cash flow in the last year.
It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.
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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. With that in mind, we're encouraged by the steady growth at McGrath, with earnings per share up 4.5% on average over the last five years. Growth has been anaemic. Yet with more than 75% of its earnings being kept in the business, there is ample room to reinvest in growth or lift the payout ratio - either of which could increase the dividend.
Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. McGrath has seen its dividend decline 8.9% per annum on average over the past six years, which is not great to see. McGrath is a rare case where dividends have been decreasing at the same time as earnings per share have been improving. It's unusual to see, and could point to unstable conditions in the core business, or more rarely an intensified focus on reinvesting profits.
Is McGrath worth buying for its dividend? Earnings per share have been growing moderately, and McGrath is paying out less than half its earnings and cash flow as dividends, which is an attractive combination as it suggests the company is investing in growth. It might be nice to see earnings growing faster, but McGrath is being conservative with its dividend payouts and could still perform reasonably over the long run. It's a promising combination that should mark this company worthy of closer attention.
On that note, you'll want to research what risks McGrath is facing. In terms of investment risks, we've identified 3 warning signs with McGrath and understanding them should be part of your investment process.
A common investing mistake is buying the first interesting stock you see. Here you can find a full list of high-yield 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.