Don't Buy Enagás, S.A. (BME:ENG) For Its Next Dividend Without Doing These Checks

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Enagás, S.A. (BME:ENG) is about to trade ex-dividend in the next three days. The ex-dividend date is usually set to be one business day before the record date which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the dividend. It is important to be aware of the ex-dividend date because any trade on the stock needs to have been settled on or before the record date. Thus, you can purchase Enagás' shares before the 17th of December in order to receive the dividend, which the company will pay on the 21st of December.

The company's upcoming dividend is €0.55 a share, following on from the last 12 months, when the company distributed a total of €1.69 per share to shareholders. Looking at the last 12 months of distributions, Enagás has a trailing yield of approximately 8.2% on its current stock price of €20.6. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether Enagás can afford its dividend, and if the dividend could grow.

View our latest analysis for Enagás

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Enagás paid out 110% of its earnings, which is more than we're comfortable with, unless there are mitigating circumstances. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. Over the last year, it paid out more than three-quarters (79%) of its free cash flow generated, which is fairly high and may be starting to limit reinvestment in the business.

It's good to see that while Enagás'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.

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

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If earnings fall far enough, the company could be forced to cut its dividend. That's why it's not ideal to see Enagás's earnings per share have been shrinking at 2.3% a year over the previous five years.

We'd also point out that Enagás issued a meaningful number of new shares in the past year. Trying to grow the dividend while issuing large amounts of new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Enagás has delivered an average of 7.3% per year annual increase in its dividend, based on the past 10 years of dividend payments. 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. Enagás is already paying out 110% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

Final Takeaway

Is Enagás worth buying for its dividend? It's never fun to see a company's earnings per share in retreat. Worse, Enagás's paying out a majority of its earnings and more than half its free cash flow. Positive cash flows are good news but it's not a good combination. 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 in mind though, if the poor dividend characteristics of Enagás don't faze you, it's worth being mindful of the risks involved with this business. In terms of investment risks, we've identified 3 warning signs with Enagás and understanding them should be part of your investment process.

If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.

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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.