Don't Buy Johnson Matthey Plc (LON:JMAT) For Its Next Dividend Without Doing These Checks

It looks like Johnson Matthey Plc (LON:JMAT) is about to go ex-dividend in the next four days. 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. 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. Accordingly, Johnson Matthey investors that purchase the stock on or after the 6th of June will not receive the dividend, which will be paid on the 6th of August.

The company's upcoming dividend is UK£0.55 a share, following on from the last 12 months, when the company distributed a total of UK£0.77 per share to shareholders. Based on the last year's worth of payments, Johnson Matthey stock has a trailing yield of around 4.4% on the current share price of UK£17.58. We love seeing companies pay a dividend, but it's also important to be sure that laying the golden eggs isn't going to kill our golden goose! So we need to check whether the dividend payments are covered, and if earnings are growing.

Check out our latest analysis for Johnson Matthey

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. Johnson Matthey distributed an unsustainably high 131% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. It paid out more than half (63%) of its free cash flow in the past year, which is within an average range for most companies.

It's good to see that while Johnson Matthey's dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Very few companies are able to sustainably pay dividends larger than their reported earnings.

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 business enters a downturn and the dividend is cut, the company could see its value fall precipitously. With that in mind, we're discomforted by Johnson Matthey's 23% per annum decline in earnings in the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Since the start of our data, 10 years ago, Johnson Matthey has lifted its dividend by approximately 2.5% 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. Johnson Matthey is already paying out 131% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

Should investors buy Johnson Matthey for the upcoming dividend? Earnings per share have been shrinking in recent times. Worse, Johnson Matthey'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 Johnson Matthey don't faze you, it's worth being mindful of the risks involved with this business. Our analysis shows 3 warning signs for Johnson Matthey and you should be aware of these before buying any shares.

Generally, we wouldn't recommend just buying the first dividend stock you see. Here's a curated list of interesting stocks that are strong dividend payers.

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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.