Dividend Investors: Don't Be Too Quick To Buy Servcorp Limited (ASX:SRV) For Its Upcoming Dividend

Readers hoping to buy Servcorp Limited (ASX:SRV) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. You will need to purchase shares before the 9th of March to receive the dividend, which will be paid on the 7th of April.

Servcorp's upcoming dividend is AU$0.09 a share, following on from the last 12 months, when the company distributed a total of AU$0.20 per share to shareholders. Based on the last year's worth of payments, Servcorp stock has a trailing yield of around 5.7% on the current share price of A$3.5. If you buy this business for its dividend, you should have an idea of whether Servcorp's dividend is reliable and sustainable. So we need to check whether the dividend payments are covered, and if earnings are growing.

View our latest analysis for Servcorp

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. Servcorp paid out a disturbingly high 231% of its profit as dividends last year, which makes us concerned there's something we don't fully understand in the business. A useful secondary check can be to evaluate whether Servcorp generated enough free cash flow to afford its dividend. The good news is it paid out just 12% of its free cash flow in the last year.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Servcorp 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 how much of its profit Servcorp paid out over the last 12 months.

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. Servcorp's earnings per share have fallen at approximately 25% a year over the previous five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the past 10 years, Servcorp has increased its dividend at approximately 7.2% 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. Servcorp is already paying out 231% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

To Sum It Up

From a dividend perspective, should investors buy or avoid Servcorp? It's not a great combination to see a company with earnings in decline and paying out 231% of its profits, which could imply the dividend may be at risk of being cut in the future. Yet cashflow was much stronger, which makes us wonder if there are some large timing issues in Servcorp's cash flows, or perhaps the company has written down some assets aggressively, reducing its income. Overall it doesn't look like the most suitable dividend stock for a long-term buy and hold investor.

With that in mind though, if the poor dividend characteristics of Servcorp don't faze you, it's worth being mindful of the risks involved with this business. Every company has risks, and we've spotted 3 warning signs for Servcorp you should know about.

If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.

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This article by Simply Wall St is general in nature. 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.
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