Here's Why We're Wary Of Buying Nichols' (LON:NICL) 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 Nichols plc (LON:NICL) is about to trade ex-dividend in the next 3 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. 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. This means that investors who purchase Nichols' shares on or after the 3rd of August will not receive the dividend, which will be paid on the 8th of September.

The company's upcoming dividend is UK£0.13 a share, following on from the last 12 months, when the company distributed a total of UK£0.28 per share to shareholders. Based on the last year's worth of payments, Nichols stock has a trailing yield of around 2.8% on the current share price of £10.1. 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 Nichols can afford its dividend, and if the dividend could grow.

See our latest analysis for Nichols

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 89% 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 concerned if earnings began to decline. 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 last year it paid out 61% of its free cash flow as dividends, within the usual range for most companies.

It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

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 decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. Readers will understand then, why we're concerned to see Nichols's earnings per share have dropped 12% a year over the past 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 past 10 years, Nichols has increased its dividend at approximately 4.9% 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. Nichols is already paying out 89% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

From a dividend perspective, should investors buy or avoid Nichols? While earnings per share are shrinking, it's encouraging to see that at least Nichols's dividend appears sustainable, with earnings and cashflow payout ratios that are within reasonable bounds. 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 Nichols as an investment, you'll find it beneficial to know what risks this stock is facing. Our analysis shows 2 warning signs for Nichols and you should be aware of them before buying any shares.

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.