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

RITES Limited (NSE:RITES) is about to trade ex-dividend in the next three days. The ex-dividend date is two business days before a company's record date in most cases, which is the date on which the company determines which shareholders are entitled to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade can take two business days or more to settle. In other words, investors can purchase RITES' shares before the 17th of September in order to be eligible for the dividend, which will be paid on the 23rd of October.

The company's next dividend payment will be ₹2.65 per share, on the back of last year when the company paid a total of ₹7.55 to shareholders. Based on the last year's worth of payments, RITES has a trailing yield of 2.8% on the current stock price of ₹267.90. 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 investigate whether RITES can afford its dividend, and if the dividend could grow.

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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. Last year RITES paid out 95% of its profits as dividends to shareholders, suggesting the dividend is not well covered by earnings. 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 last year it paid out 71% of its free cash flow as dividends, within the usual range for most companies.

It's good to see that while RITES's dividends were not well covered by profits, at least they are affordable from a cash perspective. Still, if this were to happen repeatedly, we'd be concerned about whether the dividend is sustainable in a downturn.

Check out our latest analysis for RITES

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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. RITES's earnings per share have fallen at approximately 8.2% a year over the previous five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the past seven years, RITES has increased its dividend at approximately 16% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. RITES is already paying out 95% 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 RITES for the upcoming dividend? Earnings per share have been in decline, which is not encouraging. What's more, RITES is paying out a majority of its earnings and over half its free cash flow. It's hard to say if the business has the financial resources and time to turn things around without cutting the dividend. Bottom line: RITES has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

With that in mind though, if the poor dividend characteristics of RITES don't faze you, it's worth being mindful of the risks involved with this business. For example, we've found 1 warning sign for RITES that we recommend you consider before investing in the business.

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.