Here's Why We're Wary Of Buying SalMar's (OB:SALM) For Its Upcoming Dividend

It looks like SalMar ASA (OB:SALM) is about to go ex-dividend in the next four 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. It is important to be aware of the ex-dividend date because any trade on the stock needs to have been settled on or before the record date. Therefore, if you purchase SalMar's shares on or after the 7th of June, you won't be eligible to receive the dividend, when it is paid on the 20th of June.

The company's next dividend payment will be kr035.00 per share. Last year, in total, the company distributed kr35.00 to shareholders. Based on the last year's worth of payments, SalMar stock has a trailing yield of around 5.5% on the current share price of kr0638.50. 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.

View our latest analysis for SalMar

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. SalMar paid out a disturbingly high 265% of its profit as dividends last year, which makes us concerned there's something we don't fully understand in the business. 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 distributed 41% of its free cash flow as dividends, a comfortable payout level for most companies.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and SalMar fortunately did generate enough cash to fund its dividend. 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?

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. With that in mind, we're discomforted by SalMar's 16% per annum decline in earnings in the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. SalMar has delivered 16% dividend growth per year on average over the past 10 years. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. SalMar is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.

To Sum It Up

Should investors buy SalMar for the upcoming dividend? It's not a great combination to see a company with earnings in decline and paying out 265% of its profits, which could imply the dividend may be at risk of being cut in the future. Yet cashflow was much stronger, which makes us wonder if there are some large timing issues in SalMar's cash flows, or perhaps the company has written down some assets aggressively, reducing its income. It's not that we think SalMar is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

Although, if you're still interested in SalMar and want to know more, you'll find it very useful to know what risks this stock faces. In terms of investment risks, we've identified 4 warning signs with SalMar and understanding them should be part of your investment process.

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.