Does PrairieSky Royalty Ltd. (TSE:PSK) Have A Place In Your Dividend Stock Portfolio?

Is PrairieSky Royalty Ltd. (TSE:PSK) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

With a five-year payment history and a 4.5% yield, many investors probably find PrairieSky Royalty intriguing. It sure looks interesting on these metrics - but there's always more to the story . The company also bought back stock equivalent to around 0.8% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on PrairieSky Royalty!

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. PrairieSky Royalty paid out 174% of its profit as dividends, over the trailing twelve month period. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. PrairieSky Royalty paid out 92% of its free cash flow last year, which we think is concerning if cash flows do not improve. Cash is slightly more important than profit from a dividend perspective, but given PrairieSky Royalty's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. PrairieSky Royalty has been paying a dividend for the past five years. During the past five-year period, the first annual payment was CA$1.27 in 2014, compared to CA$0.78 last year. This works out to be a decline of approximately 9.3% per year over that time.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Earnings have grown at around 3.4% a year for the past three years, which is better than seeing them shrink! Still, the company has struggled to grow its EPS, and currently pays out 174% of its earnings. As they say in finance, 'past performance is not indicative of future performance', but we are not confident a company with limited earnings growth and a high payout ratio will be a star dividend-payer over the next decade.

Conclusion

To summarise, shareholders should always check that PrairieSky Royalty's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Unfortunately, there hasn't been any earnings growth, and the company's dividend history has been too short for us to evaluate the consistency of the dividend. There are a few too many issues for us to get comfortable with PrairieSky Royalty from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 6 analysts we track are forecasting for PrairieSky Royalty for free with public analyst estimates for the company.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.