Don't Race Out To Buy Castrol India Limited (NSE:CASTROLIND) Just Because It's Going Ex-Dividend

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Castrol India Limited (NSE:CASTROLIND) is about to trade ex-dividend in the next 2 days. The ex-dividend date is usually set to be two business days before the record date, which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the dividend. The ex-dividend date is important as the process of settlement involves at least two full business days. So if you miss that date, you would not show up on the company's books on the record date. Accordingly, Castrol India investors that purchase the stock on or after the 11th of August will not receive the dividend, which will be paid on the 3rd of September.

The company's next dividend payment will be ₹3.50 per share. Last year, in total, the company distributed ₹8.50 to shareholders. Based on the last year's worth of payments, Castrol India has a trailing yield of 4.0% on the current stock price of ₹214.70. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to check whether the dividend payments are covered, and if earnings are growing.

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If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. It paid out 88% of its earnings as dividends last year, which is not unreasonable, but limits reinvestment in the business and leaves the dividend vulnerable to a business downturn. We'd be worried about the risk of a drop in 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 past year it paid out 152% 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.

Castrol India paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Were this to happen repeatedly, this would be a risk to Castrol India's ability to maintain its dividend.

See our latest analysis for Castrol India

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

Have Earnings And Dividends Been Growing?

Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're encouraged by the steady growth at Castrol India, with earnings per share up 2.9% on average over the last five years. Earnings have been growing somewhat, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the past 10 years, Castrol India has increased its dividend at approximately 9.3% a year on average. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

To Sum It Up

Should investors buy Castrol India for the upcoming dividend? Earnings per share have grown somewhat, although Castrol India paid out over half its profits and the dividend was not well covered by free cash flow. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with Castrol India. Case in point: We've spotted 1 warning sign for Castrol India you should be aware of.

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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.