Here's Why We're Wary Of Buying Williams Companies' (NYSE:WMB) For Its Upcoming Dividend

The Williams Companies, Inc. (NYSE:WMB) is about to trade ex-dividend in the next three 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 important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. This means that investors who purchase Williams Companies' shares on or after the 12th of September will not receive the dividend, which will be paid on the 29th of September.

The company's next dividend payment will be US$0.50 per share, and in the last 12 months, the company paid a total of US$2.00 per share. Looking at the last 12 months of distributions, Williams Companies has a trailing yield of approximately 3.5% on its current stock price of US$57.20. 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 Williams Companies can afford its dividend, and if the dividend could grow.

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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. Last year Williams Companies paid out 98% of its profits as dividends to shareholders, suggesting the dividend is not well covered by earnings. A useful secondary check can be to evaluate whether Williams Companies generated enough free cash flow to afford its dividend. Williams Companies paid out more free cash flow than it generated - 133%, to be precise - last year, which we think is concerningly high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

As Williams Companies'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.

Check out our latest analysis for Williams Companies

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 earnings fall far enough, the company could be forced to cut its dividend. It's encouraging to see Williams Companies has grown its earnings rapidly, up 23% a year for the past five years. Williams Companies's dividend was not well covered by earnings, although at least its earnings per share are growing quickly. Fast-growing businesses normally need to reinvest most of their earnings in order to maintain growth, so we'd suspect that either earnings growth will slow or the dividend may not be increased for a while.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Williams Companies has seen its dividend decline 1.3% per annum on average over the past 10 years, which is not great to see.

The Bottom Line

Should investors buy Williams Companies for the upcoming dividend? 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. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Although, if you're still interested in Williams Companies and want to know more, you'll find it very useful to know what risks this stock faces. Every company has risks, and we've spotted 2 warning signs for Williams Companies 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.