Here's Why We're Wary Of Buying Canadian Utilities' (TSE:CU) For Its Upcoming Dividend

Canadian Utilities Limited (TSE:CU) is about to trade ex-dividend in the next 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. Thus, you can purchase Canadian Utilities' shares before the 1st of May in order to receive the dividend, which the company will pay on the 1st of June.

The company's upcoming dividend is CA$0.4531 a share, following on from the last 12 months, when the company distributed a total of CA$1.81 per share to shareholders. Last year's total dividend payments show that Canadian Utilities has a trailing yield of 5.9% on the current share price of CA$30.64. 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.

View our latest analysis for Canadian Utilities

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. Its dividend payout ratio is 77% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth. We'd be worried about the risk of a drop in earnings. 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. Over the past year it paid out 121% of its free cash flow as dividends, which is uncomfortably high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.

Canadian Utilities 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 Canadian Utilities 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?

Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're encouraged by the steady growth at Canadian Utilities, with earnings per share up 2.1% on average over the last five years. Earnings have been growing somewhat, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the past 10 years, Canadian Utilities has increased its dividend at approximately 6.5% a year on average. 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 Canadian Utilities for the upcoming dividend? Earnings per share have grown somewhat, although Canadian Utilities paid out over half its profits and the dividend was not well covered by free cash flow. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

With that being said, if you're still considering Canadian Utilities as an investment, you'll find it beneficial to know what risks this stock is facing. For instance, we've identified 3 warning signs for Canadian Utilities (2 are a bit unpleasant) 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.