Why It Might Not Make Sense To Buy Archrock, Inc. (NYSE:AROC) For Its Upcoming Dividend

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Archrock, Inc. (NYSE:AROC) is about to trade ex-dividend in the next three days. Typically, the ex-dividend date is one business day before the record date, which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade takes at least one business day to settle. In other words, investors can purchase Archrock's shares before the 6th of May in order to be eligible for the dividend, which will be paid on the 13th of May.

The company's upcoming dividend is US$0.19 a share, following on from the last 12 months, when the company distributed a total of US$0.76 per share to shareholders. Looking at the last 12 months of distributions, Archrock has a trailing yield of approximately 3.2% on its current stock price of US$23.83. 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.

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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. Archrock paid out more than half (66%) of its earnings last year, which is a regular payout ratio for most companies. 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. Archrock paid out more free cash flow than it generated - 156%, to be precise - last year, which we think is concerningly high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.

Archrock 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 Archrock's ability to maintain its dividend.

See our latest analysis for Archrock

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 earnings fall far enough, the company could be forced to cut its dividend. This is why it's a relief to see Archrock earnings per share are up 6.7% per annum over the last five years. Earnings have been growing at a steady rate, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

We'd also point out that Archrock issued a meaningful number of new shares in the past year. Trying to grow the dividend while issuing large amounts of new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the last 10 years, Archrock has lifted its dividend by approximately 2.4% 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.

To Sum It Up

Should investors buy Archrock for the upcoming dividend? Earnings per share have grown somewhat, although Archrock paid out over half its profits and the dividend was not well covered by free cash flow. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

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 Archrock. Every company has risks, and we've spotted 2 warning signs for Archrock (of which 1 is significant!) you should know about.

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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.