Here's Why We're Wary Of Buying ALLETE's (NYSE:ALE) For Its Upcoming Dividend

ALLETE, Inc. (NYSE:ALE) is about to trade ex-dividend in the next two days. The ex-dividend date is usually set to be one business day before the record date which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the 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 ALLETE's shares on or after the 12th of May will not receive the dividend, which will be paid on the 1st of June.

The company's upcoming dividend is US$0.68 a share, following on from the last 12 months, when the company distributed a total of US$2.71 per share to shareholders. Last year's total dividend payments show that ALLETE has a trailing yield of 4.3% on the current share price of $62.5. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to investigate whether ALLETE can afford its dividend, and if the dividend could grow.

See our latest analysis for ALLETE

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. Its dividend payout ratio is 83% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth. It could become a concern if earnings started to decline. A useful secondary check can be to evaluate whether ALLETE generated enough free cash flow to afford its dividend. ALLETE paid out more free cash flow than it generated - 175%, 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.

ALLETE paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were ALLETE to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

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

Have Earnings And Dividends Been Growing?

Companies that aren't growing their earnings can still be valuable, but it is even more important to assess the sustainability of the dividend if it looks like the company will struggle to grow. If earnings fall far enough, the company could be forced to cut its dividend. It's not encouraging to see that ALLETE's earnings are effectively flat over the past five years. Better than seeing them fall off a cliff, for sure, but the best dividend stocks grow their earnings meaningfully over the long run.

ALLETE also issued more than 5% of its market cap in new stock during the past year, which we feel is likely to hurt its dividend prospects in the long run. It's hard to grow dividends per share when a company keeps creating new shares.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Since the start of our data, 10 years ago, ALLETE has lifted its dividend by approximately 3.9% a year on average.

Final Takeaway

Should investors buy ALLETE for the upcoming dividend? Earnings per share have not grown and ALLETE's profit payout ratio looks reasonable. However, it paid out a disconcertingly high percentage of its cashflow, which is a worry. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of ALLETE.

With that being said, if you're still considering ALLETE as an investment, you'll find it beneficial to know what risks this stock is facing. Be aware that ALLETE is showing 2 warning signs in our investment analysis, and 1 of those is significant...

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.