Don't Race Out To Buy Trustpower Limited (NZSE:TPW) Just Because It's Going Ex-Dividend

Trustpower Limited (NZSE:TPW) is about to trade ex-dividend in the next four days. You can purchase shares before the 26th of November in order to receive the dividend, which the company will pay on the 4th of December.

Trustpower's next dividend payment will be NZ$0.20 per share. Last year, in total, the company distributed NZ$0.46 to shareholders. Calculating the last year's worth of payments shows that Trustpower has a trailing yield of 6.1% on the current share price of NZ$7.58. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

View our latest analysis for Trustpower

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. Trustpower distributed an unsustainably high 113% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. A useful secondary check can be to evaluate whether Trustpower generated enough free cash flow to afford its dividend. Over the last year, it paid out more than three-quarters (79%) of its free cash flow generated, which is fairly high and may be starting to limit reinvestment in the business.

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

Companies with falling earnings are riskier for dividend shareholders. 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 Trustpower's 8.9% 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.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the last four years, Trustpower has lifted its dividend by approximately 9.5% a year on average. 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. Trustpower is already paying out 113% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

Is Trustpower an attractive dividend stock, or better left on the shelf? Earnings per share have been in decline, which is not encouraging. What's more, Trustpower is paying out a majority of its earnings and over half its free cash flow. It's hard to say if the business has the financial resources and time to turn things around without cutting the dividend. 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 Trustpower as an investment, you'll find it beneficial to know what risks this stock is facing. To help with this, we've discovered 2 warning signs for Trustpower (1 is concerning!) that you ought to be aware of before buying the shares.

If you're in the market for dividend stocks, we recommend checking our list of top 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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