It Might Not Be A Great Idea To Buy Sitio Royalties Corp. (NYSE:STR) For Its Next Dividend

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 Sitio Royalties Corp. (NYSE:STR) is about to go ex-dividend in just four 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. Accordingly, Sitio Royalties investors that purchase the stock on or after the 14th of March will not receive the dividend, which will be paid on the 28th of March.

The company's next dividend payment will be US$0.41 per share. Last year, in total, the company distributed US$1.40 to shareholders. Calculating the last year's worth of payments shows that Sitio Royalties has a trailing yield of 7.2% on the current share price of US$19.51. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. We need to see whether the dividend is covered by earnings and if it's growing.

See our latest analysis for Sitio Royalties

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. An unusually high payout ratio of 284% of its profit suggests something is happening other than the usual distribution of profits to shareholders. A useful secondary check can be to evaluate whether Sitio Royalties 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.

As Sitio Royalties's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

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

Have Earnings And Dividends Been Growing?

Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. It's encouraging to see Sitio Royalties has grown its earnings rapidly, up 350% a year for the past three years. Sitio Royalties's dividend was not well covered by earnings, although at least its earnings per share are growing quickly. Generally, when a company is growing this quickly and paying out all of its earnings as dividends, it can suggest either that the company is borrowing heavily to fund its growth, or that earnings growth is likely to slow due to lack of reinvestment.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Sitio Royalties has seen its dividend decline 21% per annum on average over the past three years, which is not great to see. Sitio Royalties is a rare case where dividends have been decreasing at the same time as earnings per share have been improving. It's unusual to see, and could point to unstable conditions in the core business, or more rarely an intensified focus on reinvesting profits.

To Sum It Up

From a dividend perspective, should investors buy or avoid Sitio Royalties? Earnings per share have been growing, despite the company paying out a concerningly high percentage of its earnings and cashflow. We struggle to see how a company paying out so much of its earnings and cash flow will be able to sustain its dividend in a downturn, or reinvest enough into its business to continue growing earnings without borrowing heavily. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Sitio Royalties.

Although, if you're still interested in Sitio Royalties and want to know more, you'll find it very useful to know what risks this stock faces. For example - Sitio Royalties has 1 warning sign we think you should be aware of.

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.