It Might Not Be A Great Idea To Buy Scales Corporation Limited (NZSE:SCL) For Its Next Dividend

Scales Corporation Limited (NZSE:SCL) is about to trade ex-dividend in the next 4 days. You can purchase shares before the 5th of January in order to receive the dividend, which the company will pay on the 15th of January.

Scales's upcoming dividend is NZ$0.11 a share, following on from the last 12 months, when the company distributed a total of NZ$0.19 per share to shareholders. Last year's total dividend payments show that Scales has a trailing yield of 3.8% on the current share price of NZ$4.98. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. As a result, readers should always check whether Scales has been able to grow its dividends, or if the dividend might be cut.

Check out our latest analysis for Scales

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Scales distributed an unsustainably high 114% of its profit as dividends to shareholders last year. Without extenuating circumstances, we'd consider the dividend at risk of a cut. 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. It paid out 80% of its free cash flow as dividends, which is within usual limits but will limit the company's ability to lift the dividend if there's no growth.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Scales 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?

Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. With that in mind, we're encouraged by the steady growth at Scales, with earnings per share up 3.3% on average over the last five years.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. Scales has delivered 11% dividend growth per year on average over the past six years. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

The Bottom Line

Should investors buy Scales for the upcoming dividend? Earnings per share have not grown all that much, and the company is paying out an uncomfortably high percentage of its income. Fortunately it paid out a lower percentage of its cash flow. Overall it doesn't look like the most suitable dividend stock for a long-term buy and hold investor.

With that being said, if you're still considering Scales as an investment, you'll find it beneficial to know what risks this stock is facing. For example - Scales has 3 warning signs we think you should be aware of.

A common investment mistake is buying the first interesting stock you see. Here you can find a list of promising dividend stocks with a greater than 2% yield and an upcoming dividend.

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This article by Simply Wall St is general in nature. 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.
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