Some investors rely on dividends for growing their wealth, and if you're one of those dividend sleuths, you might be intrigued to know that Watsco, Inc. (NYSE:WSO) is about to go ex-dividend in just 3 days. The ex-dividend date is one business day before a company's record date, which is the date on which the company determines which shareholders are entitled to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade takes at least two business day to settle. Thus, you can purchase Watsco's shares before the 13th of April in order to receive the dividend, which the company will pay on the 29th of April.
The company's next dividend payment will be US$2.20 per share, on the back of last year when the company paid a total of US$7.80 to shareholders. Calculating the last year's worth of payments shows that Watsco has a trailing yield of 2.6% on the current share price of $300.36. 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 Watsco can afford its dividend, and if the dividend could grow.
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. Watsco paid out more than half (70%) of its earnings last year, which is a regular payout ratio for most companies. A useful secondary check can be to evaluate whether Watsco generated enough free cash flow to afford its dividend. The company paid out 91% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Cash flows are usually much more volatile than earnings, so this could be a temporary effect - but we'd generally want to look more closely here.
Watsco paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Watsco to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.
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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Fortunately for readers, Watsco's earnings per share have been growing at 16% a year for the past five years. Earnings have been growing at a decent rate, 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 last 10 years, Watsco has lifted its dividend by approximately 13% a year on average. It's great to see earnings per share growing rapidly over several years, and dividends per share growing right along with it.
The Bottom Line
Is Watsco an attractive dividend stock, or better left on the shelf? It's good to see that earnings per share are growing and that the company's payout ratio is within a normal range for most businesses. However we're somewhat concerned that it paid out 91% of its cashflow, which is uncomfortably high. Overall, it's not a bad combination, but we feel that there are likely more attractive dividend prospects out there.
With that being said, if dividends aren't your biggest concern with Watsco, you should know about the other risks facing this business. Case in point: We've spotted 1 warning sign for Watsco you should be aware of.
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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.