It Might Not Be A Great Idea To Buy Eiken Chemical Co., Ltd. (TSE:4549) For Its Next Dividend

Eiken Chemical Co., Ltd. (TSE:4549) stock is about to trade ex-dividend in three 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 of consequence because whenever a stock is bought or sold, the trade takes at least two business day to settle. Therefore, if you purchase Eiken Chemical's shares on or after the 27th of September, you won't be eligible to receive the dividend, when it is paid on the 2nd of December.

The company's next dividend payment will be JP¥26.00 per share, on the back of last year when the company paid a total of JP¥53.00 to shareholders. Looking at the last 12 months of distributions, Eiken Chemical has a trailing yield of approximately 2.2% on its current stock price of JP¥2369.00. If you buy this business for its dividend, you should have an idea of whether Eiken Chemical's dividend is reliable and sustainable. We need to see whether the dividend is covered by earnings and if it's growing.

View our latest analysis for Eiken Chemical

Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. It paid out 78% 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. It could become a concern if earnings started to decline. 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 112% of its free cash flow as dividends, which is uncomfortably high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Eiken Chemical does have a large net cash position on the balance sheet, which could fund large dividends for a time, if the company so chose. Still, smart investors know that it is better to assess dividends relative to the cash and profit generated by the business. Paying dividends out of cash on the balance sheet is not long-term sustainable.

Eiken Chemical 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 Eiken Chemical 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 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 discomforted by Eiken Chemical's 6.2% 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.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. Eiken Chemical has delivered 13% dividend growth per year on average over the past 10 years. 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. Eiken Chemical is already paying out 78% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

To Sum It Up

Is Eiken Chemical 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 Eiken Chemical is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

So if you're still interested in Eiken Chemical despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. For example, we've found 2 warning signs for Eiken Chemical 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.