Here's Why We're Wary Of Buying RITES' (NSE:RITES) 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 RITES Limited (NSE:RITES) is about to trade ex-dividend in the next 3 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. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade takes at least two business day to settle. This means that investors who purchase RITES' shares on or after the 14th of November will not receive the dividend, which will be paid on the 6th of December.

The company's upcoming dividend is ₹1.75 a share, following on from the last 12 months, when the company distributed a total of ₹9.00 per share to shareholders. Looking at the last 12 months of distributions, RITES has a trailing yield of approximately 3.2% on its current stock price of ₹284.45. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

See our latest analysis for RITES

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. RITES is paying out an acceptable 59% of its profit, a common payout level among most companies. 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. Over the past year it paid out 117% of its free cash flow as dividends, which is uncomfortably high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.

RITES 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 RITES to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If earnings fall far enough, the company could be forced to cut its dividend. So we're not too excited that RITES's earnings are down 2.5% a year over the past five years.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. RITES has delivered an average of 23% per year annual increase in its dividend, based on the past six years of dividend payments. 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

Is RITES an attractive dividend stock, or better left on the shelf? 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. It's not that we think RITES is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

With that being said, if you're still considering RITES as an investment, you'll find it beneficial to know what risks this stock is facing. For example - RITES has 1 warning sign we think you should be aware of.

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.