Why It Might Not Make Sense To Buy Diversified Royalty Corp. (TSE:DIV) 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 Diversified Royalty Corp. (TSE:DIV) is about to go ex-dividend in just four days. The ex-dividend date is two business days before a company's record date in most cases, which is the date on which the company determines which shareholders are entitled to receive a dividend. The ex-dividend date is an important date to be aware of as any purchase of the stock made on or after this date might mean a late settlement that doesn't show on the record date. In other words, investors can purchase Diversified Royalty's shares before the 15th of May in order to be eligible for the dividend, which will be paid on the 30th of May.

The company's next dividend payment will be CA$0.02083 per share, on the back of last year when the company paid a total of CA$0.25 to shareholders. Based on the last year's worth of payments, Diversified Royalty stock has a trailing yield of around 8.6% on the current share price of CA$2.92. 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.

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If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Diversified Royalty paid out 152% 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. 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. It paid out more than half (75%) of its free cash flow in the past year, which is within an average range for most companies.

It's good to see that while Diversified Royalty's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

Check out our latest analysis for Diversified Royalty

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 business enters a downturn and the dividend is cut, the company could see its value fall precipitously. This is why it's a relief to see Diversified Royalty earnings per share are up 4.0% per annum over the last five years.

Diversified Royalty also issued more than 5% of its market cap in new stock during the past year, which we feel is likely to hurt its dividend prospects in the long run. It's hard to grow dividends per share when a company keeps creating new shares.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Diversified Royalty has delivered 2.9% dividend growth per year on average over the past 10 years. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

The Bottom Line

Should investors buy Diversified Royalty for the upcoming dividend? Earnings per share have not grown all that much, and the company is paying out an uncomfortably high percentage of its income. Fortunately it paid out a lower percentage of its cash flow. Bottom line: Diversified Royalty has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

With that being said, if you're still considering Diversified Royalty as an investment, you'll find it beneficial to know what risks this stock is facing. Every company has risks, and we've spotted 2 warning signs for Diversified Royalty you should know about.

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.