Don't Buy Gear Energy Ltd. (TSE:GXE) For Its Next Dividend Without Doing These Checks

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 Gear Energy Ltd. (TSE:GXE) is about to go ex-dividend in just 2 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 important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. In other words, investors can purchase Gear Energy's shares before the 14th of June in order to be eligible for the dividend, which will be paid on the 28th of June.

The company's upcoming dividend is CA$0.005 a share, following on from the last 12 months, when the company distributed a total of CA$0.06 per share to shareholders. Calculating the last year's worth of payments shows that Gear Energy has a trailing yield of 8.5% on the current share price of CA$0.71. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. We need to see whether the dividend is covered by earnings and if it's growing.

Check out our latest analysis for Gear Energy

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. Gear Energy paid out a disturbingly high 229% of its profit as dividends last year, which makes us concerned there's something we don't fully understand in the business. 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 company paid out 99% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Cash flows are usually much more volatile than earnings, so this could be a temporary effect - but we'd generally want to look more closely here.

Cash is slightly more important than profit from a dividend perspective, but given Gear Energy'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?

Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. If earnings fall far enough, the company could be forced to cut its dividend. This is why it's a relief to see Gear Energy earnings per share are up 6.7% per annum over the last five years. Earnings per share have been growing comfortably, although unfortunately the company is paying out more of its profits than we're comfortable with over the long term.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the past two years, Gear Energy has increased its dividend at approximately 22% a year on average. We're glad to see dividends rising alongside earnings over a number of years, which may be a sign the company intends to share the growth with shareholders.

The Bottom Line

Should investors buy Gear Energy for the upcoming dividend? The dividends are not well covered by either income or free cash flow, although at least earnings per share are slowly increasing. It's not that we think Gear Energy is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

So if you're still interested in Gear Energy despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. For example, we've found 2 warning signs for Gear Energy that we recommend you consider before investing in the business.

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.