Here's Why We're Wary Of Buying Freehold Royalties' (TSE:FRU) For Its Upcoming Dividend

Readers hoping to buy Freehold Royalties Ltd. (TSE:FRU) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. The ex-dividend date is usually set to be one business day before the record date which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the 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. Therefore, if you purchase Freehold Royalties' shares on or after the 31st of July, you won't be eligible to receive the dividend, when it is paid on the 15th of August.

The company's upcoming dividend is CA$0.09 a share, following on from the last 12 months, when the company distributed a total of CA$1.08 per share to shareholders. Based on the last year's worth of payments, Freehold Royalties stock has a trailing yield of around 7.6% on the current share price of CA$14.29. We love seeing companies pay a dividend, but it's also important to be sure that laying the golden eggs isn't going to kill our golden goose! So we need to check whether the dividend payments are covered, and if earnings are growing.

Check out our latest analysis for Freehold Royalties

Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Freehold Royalties paid out 121% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance. A useful secondary check can be to evaluate whether Freehold Royalties generated enough free cash flow to afford its dividend. Freehold Royalties paid out more free cash flow than it generated - 164%, to be precise - last year, which we think is concerningly 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.

Cash is slightly more important than profit from a dividend perspective, but given Freehold Royalties's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

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

Have Earnings And Dividends Been Growing?

Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. That's why it's comforting to see Freehold Royalties's earnings have been skyrocketing, up 50% per annum for the past five years. Earnings per share have been growing rapidly, but the company is paying out a dividend that looks unsustainably high. Companies that pay out more than they earned while growing rapidly, can find themselves short of cash in a few years when growth slows.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Freehold Royalties's dividend payments per share have declined at 4.3% per year on average over the past 10 years, which is uninspiring. It's unusual to see earnings per share increasing at the same time as dividends per share have been in decline. We'd hope it's because the company is reinvesting heavily in its business, but it could also suggest business is lumpy.

Final Takeaway

Is Freehold Royalties worth buying for its dividend? Earnings per share have been growing, despite the company paying out a concerningly high percentage of its earnings and cashflow. We struggle to see how a company paying out so much of its earnings and cash flow will be able to sustain its dividend in a downturn, or reinvest enough into its business to continue growing earnings without borrowing heavily. It's not that we think Freehold Royalties is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

With that in mind though, if the poor dividend characteristics of Freehold Royalties don't faze you, it's worth being mindful of the risks involved with this business. To help with this, we've discovered 1 warning sign for Freehold Royalties that you should be aware of before investing in their shares.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com