Here's Why We're Wary Of Buying Argan's (NYSE:AGX) For Its Upcoming Dividend

Readers hoping to buy Argan, Inc. (NYSE:AGX) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. If you purchase the stock on or after the 18th of December, you won't be eligible to receive this dividend, when it is paid on the 29th of December.

The upcoming dividend for Argan will put a total of US$1.25 per share in shareholders' pockets, up from last year's total dividends of US$1.00. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. We need to see whether the dividend is covered by earnings and if it's growing.

Check out our latest analysis for Argan

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. Last year, Argan paid out 220% of its profit to shareholders in the form of dividends. This is not sustainable behaviour and requires a closer look on behalf of the purchaser. 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. Luckily it paid out just 2.2% of its free cash flow last year.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Argan 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. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. Readers will understand then, why we're concerned to see Argan's earnings per share have dropped 26% a year over 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 eight years, Argan has lifted its dividend by approximately 6.6% 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. Argan 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.

The Bottom Line

Is Argan an attractive dividend stock, or better left on the shelf? It's not a great combination to see a company with earnings in decline and paying out 220% of its profits, which could imply the dividend may be at risk of being cut in the future. However, the cash payout ratio was much lower - good news from a dividend perspective - which makes us wonder why there is such a mis-match between income and cashflow. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Argan.

Although, if you're still interested in Argan and want to know more, you'll find it very useful to know what risks this stock faces. To help with this, we've discovered 3 warning signs for Argan that you should be aware of before investing in their shares.

We wouldn't recommend just buying the first dividend stock you see, though. Here's a list of interesting 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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