Don't Buy Open Text Corporation (NASDAQ:OTEX) For Its Next Dividend Without Doing These Checks

Readers hoping to buy Open Text Corporation (NASDAQ:OTEX) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. 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 important as the process of settlement involves two full business days. So if you miss that date, you would not show up on the company's books on the record date. Thus, you can purchase Open Text's shares before the 3rd of June in order to receive the dividend, which the company will pay on the 25th of June.

The company's upcoming dividend is US$0.20 a share, following on from the last 12 months, when the company distributed a total of US$0.80 per share to shareholders. Based on the last year's worth of payments, Open Text stock has a trailing yield of around 1.7% on the current share price of $46.98. We love seeing companies pay a dividend, but it's also important to be sure that laying the golden eggs isn't going to kill our golden goose! So we need to check whether the dividend payments are covered, and if earnings are growing.

Check out our latest analysis for Open Text

Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Open Text distributed an unsustainably high 131% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. A useful secondary check can be to evaluate whether Open Text generated enough free cash flow to afford its dividend. Fortunately, it paid out only 25% of its free cash flow in the past year.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Open Text fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

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

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. With that in mind, we're discomforted by Open Text's 9.8% per annum decline in earnings in the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Since the start of our data, eight years ago, Open Text has lifted its dividend by approximately 13% 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. Open Text is already paying out 131% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

Has Open Text got what it takes to maintain its dividend payments? It's never great to see earnings per share declining, especially when a company is paying out 131% of its profit as dividends, which we feel is uncomfortably high. Yet cashflow was much stronger, which makes us wonder if there are some large timing issues in Open Text's cash flows, or perhaps the company has written down some assets aggressively, reducing its income. 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 Open Text despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. For example, we've found 4 warning signs for Open Text that we recommend you consider before investing in the business.

If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.

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This article by Simply Wall St is general in nature. 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.
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