Do These 3 Checks Before Buying Tech Mahindra Limited (NSE:TECHM) For Its Upcoming Dividend

It looks like Tech Mahindra Limited (NSE:TECHM) is about to go ex-dividend in the next four days. Typically, the ex-dividend date is one business day before the record date which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. This means that investors who purchase Tech Mahindra's shares on or after the 31st of October will not receive the dividend, which will be paid on the 17th of November.

The company's next dividend payment will be ₹15.00 per share, and in the last 12 months, the company paid a total of ₹40.00 per share. Last year's total dividend payments show that Tech Mahindra has a trailing yield of 2.3% on the current share price of ₹1716.45. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether Tech Mahindra can afford its dividend, and if the dividend could grow.

See our latest analysis for Tech Mahindra

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. Tech Mahindra distributed an unsustainably high 116% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. It paid out more than half (69%) 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 Tech Mahindra's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

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

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. 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 Tech Mahindra's 5.3% per annum decline in earnings in the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the last 10 years, Tech Mahindra has lifted its dividend by approximately 23% 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. Tech Mahindra is already paying out 116% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

Has Tech Mahindra got what it takes to maintain its dividend payments? Earnings per share have been shrinking in recent times. Additionally, Tech Mahindra is paying out quite a high percentage of its earnings, and more than half its cash flow, so it's hard to evaluate whether the company is reinvesting enough in its business to improve its situation. It's not that we think Tech Mahindra is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

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 Tech Mahindra. Our analysis shows 1 warning sign for Tech Mahindra and you should be aware of it 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.