It Might Not Be A Great Idea To Buy Cummins India Limited (NSE:CUMMINSIND) For Its Next Dividend

Readers hoping to buy Cummins India Limited (NSE:CUMMINSIND) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. If you purchase the stock on or after the 9th of February, you won't be eligible to receive this dividend, when it is paid on the 24th of February.

Cummins India's upcoming dividend is ₹7.00 a share, following on from the last 12 months, when the company distributed a total of ₹14.00 per share to shareholders. Based on the last year's worth of payments, Cummins India stock has a trailing yield of around 1.8% on the current share price of ₹784.5. 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.

See our latest analysis for Cummins India

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Cummins India is paying out an acceptable 61% of its profit, a common payout level among most companies. A useful secondary check can be to evaluate whether Cummins India generated enough free cash flow to afford its dividend. Over the last year, it paid out dividends equivalent to 287% of what it generated in free cash flow, a disturbingly high percentage. It's pretty hard to pay out more than you earn, so we wonder how Cummins India intends to continue funding this dividend, or if it could be forced to cut the payment.

Cummins India paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Cummins India to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Click here to see how much of its profit Cummins India paid out over the last 12 months.

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. That's why it's not ideal to see Cummins India's earnings per share have been shrinking at 3.8% a year over the previous five years.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the last 10 years, Cummins India has lifted its dividend by approximately 5.0% a year on average. That's interesting, but the combination of a growing dividend despite declining earnings can typically only be achieved by paying out more of the company's profits. This can be valuable for shareholders, but it can't go on forever.

The Bottom Line

Should investors buy Cummins India for the upcoming dividend? It's definitely not great to see earnings per share shrinking. The company paid out an acceptable percentage of its income, but an uncomfortably high percentage of its cash flow over the past year. Bottom line: Cummins India has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

With that being said, if you're still considering Cummins India as an investment, you'll find it beneficial to know what risks this stock is facing. We've identified 3 warning signs with Cummins India (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.

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This article by Simply Wall St is general in nature. 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.
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