Why It Might Not Make Sense To Buy freenet AG (ETR:FNTN) For Its Upcoming Dividend

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see freenet AG (ETR:FNTN) is about to trade ex-dividend in the next three 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. This means that investors who purchase freenet's shares on or after the 9th of May will not receive the dividend, which will be paid on the 14th of May.

The company's next dividend payment will be €1.77 per share. Last year, in total, the company distributed €1.77 to shareholders. Last year's total dividend payments show that freenet has a trailing yield of 7.0% on the current share price of €25.16. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. As a result, readers should always check whether freenet has been able to grow its dividends, or if the dividend might be cut.

See our latest analysis for freenet

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. freenet paid out 136% 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 freenet generated enough free cash flow to afford its dividend. Dividends consumed 58% of the company's free cash flow last year, which is within a normal range for most dividend-paying organisations.

It's good to see that while freenet's dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

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

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. freenet's earnings per share have fallen at approximately 5.7% a year over the previous five years. Such a sharp decline casts doubt on the future sustainability of the dividend.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the last 10 years, freenet has lifted its dividend by approximately 2.7% a year on average. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. freenet is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.

To Sum It Up

Is freenet worth buying for its dividend? Earnings per share have been shrinking in recent times. What's more, freenet is paying out a majority of its earnings and over half its free cash flow. It's hard to say if the business has the financial resources and time to turn things around without cutting the dividend. It's not that we think freenet 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 freenet don't faze you, it's worth being mindful of the risks involved with this business. In terms of investment risks, we've identified 1 warning sign with freenet and understanding them should be part of your investment process.

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.