Dividend Investors: Don't Be Too Quick To Buy Phillips 66 (NYSE:PSX) For Its Upcoming Dividend

It looks like Phillips 66 (NYSE:PSX) is about to go ex-dividend in the next four days. The ex-dividend date occurs one day before the record date, which is the day on which shareholders need to be on the company's books in order 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. This means that investors who purchase Phillips 66's shares on or after the 17th of November will not receive the dividend, which will be paid on the 1st of December.

The company's next dividend payment will be US$1.20 per share. Last year, in total, the company distributed US$4.80 to shareholders. Based on the last year's worth of payments, Phillips 66 has a trailing yield of 3.4% on the current stock price of US$140.85. If you buy this business for its dividend, you should have an idea of whether Phillips 66's dividend is reliable and sustainable. So we need to check whether the dividend payments are covered, and if earnings are growing.

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Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. Phillips 66 paid out 128% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance. 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. Phillips 66 paid out more free cash flow than it generated - 142%, 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.

Cash is slightly more important than profit from a dividend perspective, but given Phillips 66's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Check out our latest analysis for Phillips 66

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Readers will understand then, why we're concerned to see Phillips 66's earnings per share have dropped 11% 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 10 years, Phillips 66 has lifted its dividend by approximately 9.1% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. Phillips 66 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.

Final Takeaway

Has Phillips 66 got what it takes to maintain its dividend payments? Not only are earnings per share declining, but Phillips 66 is paying out an uncomfortably high percentage of both its earnings and cashflow to shareholders as dividends. This is a starkly negative combination that often suggests a dividend cut could be in the company's near future. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

So if you're still interested in Phillips 66 despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. Our analysis shows 4 warning signs for Phillips 66 that we strongly recommend you have a look at before investing in the company.

If you're in the market for strong dividend payers, we recommend checking our selection of top dividend stocks.

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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.