Why It Might Not Make Sense To Buy British American Tobacco p.l.c. (LON:BATS) 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 British American Tobacco p.l.c. (LON:BATS) is about to go ex-dividend in just four days. The ex-dividend date is one business day before the record date, which is the cut-off date for shareholders to be present on the company's books to be eligible for a dividend payment. 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. This means that investors who purchase British American Tobacco's shares on or after the 21st of December will not receive the dividend, which will be paid on the 1st of February.

The company's upcoming dividend is UK£0.58 a share, following on from the last 12 months, when the company distributed a total of UK£2.31 per share to shareholders. Based on the last year's worth of payments, British American Tobacco stock has a trailing yield of around 10.0% on the current share price of £23.115. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

Check out our latest analysis for British American Tobacco

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. British American Tobacco paid out 58% of its earnings to investors last year, a normal payout level for most businesses. 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. It paid out more than half (50%) of its free cash flow in the past year, which is within an average range for most companies.

It's positive to see that British American Tobacco's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

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. British American Tobacco's earnings per share have fallen at approximately 27% a year over the previous five years. Such a sharp decline casts doubt on the future sustainability of the dividend.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. British American Tobacco has delivered 5.5% dividend growth per year on average over the past 10 years. Growing the dividend payout ratio while earnings are declining can deliver nice returns for a while, but it's always worth checking for when the company can't increase the payout ratio any more - because then the music stops.

The Bottom Line

Is British American Tobacco an attractive dividend stock, or better left on the shelf? While earnings per share are shrinking, it's encouraging to see that at least British American Tobacco's dividend appears sustainable, with earnings and cashflow payout ratios that are within reasonable bounds. It's not that we think British American Tobacco is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

So if you're still interested in British American Tobacco despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. In terms of investment risks, we've identified 2 warning signs with British American Tobacco 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.