Why It Might Not Make Sense To Buy Gulf Keystone Petroleum Limited (LON:GKP) 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 Gulf Keystone Petroleum Limited (LON:GKP) is about to go ex-dividend in just 3 days. Typically, the ex-dividend date is one business day before the record date which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. In other words, investors can purchase Gulf Keystone Petroleum's shares before the 17th of October in order to be eligible for the dividend, which will be paid on the 31st of October.

The company's upcoming dividend is US$0.09216 a share, following on from the last 12 months, when the company distributed a total of US$0.14 per share to shareholders. Calculating the last year's worth of payments shows that Gulf Keystone Petroleum has a trailing yield of 7.7% on the current share price of UK£1.35. 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 Gulf Keystone Petroleum has been able to grow its dividends, or if the dividend might be cut.

See our latest analysis for Gulf Keystone Petroleum

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Gulf Keystone Petroleum lost money last year, so the fact that it's paying a dividend is certainly disconcerting. There might be a good reason for this, but we'd want to look into it further before getting comfortable. Given that the company reported a loss last year, we now need to see if it generated enough free cash flow to fund the dividend. If Gulf Keystone Petroleum didn't generate enough cash to pay the dividend, then it must have either paid from cash in the bank or by borrowing money, neither of which is sustainable in the long term. Gulf Keystone Petroleum paid out more free cash flow than it generated - 111%, to be precise - last year, which we think is concerningly high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Gulf Keystone Petroleum does have a large net cash position on the balance sheet, which could fund large dividends for a time, if the company so chose. Still, smart investors know that it is better to assess dividends relative to the cash and profit generated by the business. Paying dividends out of cash on the balance sheet is not long-term sustainable.

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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Gulf Keystone Petroleum reported a loss last year, but at least the general trend suggests its income has been improving over the past five years. Even so, an unprofitable company whose business does not quickly recover is usually not a good candidate for dividend investors.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. Gulf Keystone Petroleum has seen its dividend decline 7.5% per annum on average over the past six years, which is not great to see.

Get our latest analysis on Gulf Keystone Petroleum's balance sheet health here.

Final Takeaway

Should investors buy Gulf Keystone Petroleum for the upcoming dividend? We're a bit uncomfortable with it paying a dividend while being loss-making, especially given that the dividend was not well covered by free cash flow. Bottom line: Gulf Keystone Petroleum has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

So if you're still interested in Gulf Keystone Petroleum despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. For example, we've found 1 warning sign for Gulf Keystone Petroleum that we recommend you consider before investing in the business.

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.