Don't Race Out To Buy XP Power Limited (LON:XPP) Just Because It's Going Ex-Dividend

Readers hoping to buy XP Power Limited (LON:XPP) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. The ex-dividend date occurs one day before the record date which is the day on which shareholders need to be on the company's books in order 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. In other words, investors can purchase XP Power's shares before the 7th of September in order to be eligible for the dividend, which will be paid on the 12th of October.

The company's upcoming dividend is UK£0.19 a share, following on from the last 12 months, when the company distributed a total of UK£0.94 per share to shareholders. Calculating the last year's worth of payments shows that XP Power has a trailing yield of 4.5% on the current share price of £21.1. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. We need to see whether the dividend is covered by earnings and if it's growing.

Check out our latest analysis for XP Power

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. It paid out 79% of its earnings as dividends last year, which is not unreasonable, but limits reinvestment in the business and leaves the dividend vulnerable to a business downturn. It could become a concern if earnings started to decline. A useful secondary check can be to evaluate whether XP Power generated enough free cash flow to afford its dividend. Over the past year it paid out 118% 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.

While XP Power's dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were this to happen repeatedly, this would be a risk to XP Power's ability to maintain its dividend.

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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. So we're not too excited that XP Power's earnings are down 4.4% a year over the past five years.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the last 10 years, XP Power has lifted its dividend by approximately 6.5% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. XP Power 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.

The Bottom Line

Has XP Power got what it takes to maintain its dividend payments? XP Power had an average payout ratio, but its free cash flow was lower and earnings per share have been declining. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

So if you're still interested in XP Power despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. To help with this, we've discovered 2 warning signs for XP Power that you should be aware of before investing in their shares.

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.