Here's Why We're Wary Of Buying ELAN Microelectronics' (TWSE:2458) For Its Upcoming Dividend

It looks like ELAN Microelectronics Corporation (TWSE:2458) is about to go ex-dividend in the next 3 days. The ex-dividend date is usually set to be two business days before the record date, which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the 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. Thus, you can purchase ELAN Microelectronics' shares before the 27th of March in order to receive the dividend, which the company will pay on the 17th of April.

The company's next dividend payment will be NT$3.763396 per share, on the back of last year when the company paid a total of NT$8.12 to shareholders. Calculating the last year's worth of payments shows that ELAN Microelectronics has a trailing yield of 4.9% on the current share price of NT$158.50. 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 ELAN Microelectronics can afford its dividend, and if the dividend could grow.

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Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Its dividend payout ratio is 81% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth. We'd be worried about the risk of a drop in earnings. 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. The company paid out 108% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Companies usually need cash more than they need earnings - expenses don't pay themselves - so it's not great to see it paying out so much of its cash flow.

ELAN Microelectronics paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Were this to happen repeatedly, this would be a risk to ELAN Microelectronics's ability to maintain its dividend.

See our latest analysis for ELAN Microelectronics

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 ELAN Microelectronics, with earnings per share up 2.2% on average over the last five years. Earnings have been growing somewhat, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the past 10 years, ELAN Microelectronics has increased its dividend at approximately 4.4% a year on average. We're glad to see dividends rising alongside earnings over a number of years, which may be a sign the company intends to share the growth with shareholders.

Final Takeaway

From a dividend perspective, should investors buy or avoid ELAN Microelectronics? ELAN Microelectronics is paying out a reasonable percentage of its income and an uncomfortably high 108% of its cash flow as dividends. At least earnings per share have been growing steadily. Bottom line: ELAN Microelectronics has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

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 ELAN Microelectronics. Every company has risks, and we've spotted 1 warning sign for ELAN Microelectronics you should know about.

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.