Why It Might Not Make Sense To Buy Grendene S.A. (BVMF:GRND3) For Its Upcoming Dividend

Some investors rely on dividends for growing their wealth, and if you're one of those dividend sleuths, you might be intrigued to know that Grendene S.A. (BVMF:GRND3) is about to go ex-dividend in just four days. 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 of consequence because whenever a stock is bought or sold, the trade takes at least two business day to settle. Accordingly, Grendene investors that purchase the stock on or after the 3rd of May will not receive the dividend, which will be paid on the 15th of May.

The company's next dividend payment will be R$0.1616296 per share. Last year, in total, the company distributed R$0.31 to shareholders. Based on the last year's worth of payments, Grendene has a trailing yield of 5.1% on the current stock price of R$6.11. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. We need to see whether the dividend is covered by earnings and if it's growing.

View our latest analysis for Grendene

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. Grendene paid out more than half (51%) of its earnings last year, which is a regular payout ratio for most companies. A useful secondary check can be to evaluate whether Grendene generated enough free cash flow to afford its dividend. Over the past year it paid out 183% of its free cash flow as dividends, which is uncomfortably high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Grendene does have a large net cash position on the balance sheet, which could fund large dividends for a time, if the company so chose. Still, smart investors know that it is better to assess dividends relative to the cash and profit generated by the business. Paying dividends out of cash on the balance sheet is not long-term sustainable.

Grendene paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Grendene to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. It's not encouraging to see that Grendene's earnings are 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. Grendene has seen its dividend decline 0.6% per annum on average over the past 10 years, which is not great to see.

Final Takeaway

From a dividend perspective, should investors buy or avoid Grendene? It's not great to see earnings per share have been flat and that the company paid out an uncomfortably high percentage of its cash flow over the past year. Cash flows are typically more volatile than earnings, but this is still not what we like to see. Bottom line: Grendene has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with Grendene. Case in point: We've spotted 1 warning sign for Grendene you should be aware of.

If you're in the market for strong dividend payers, we recommend checking our selection of top 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.