Here's Why We're Wary Of Buying Woolworths Holdings' (JSE:WHL) For Its Upcoming Dividend

Woolworths Holdings Limited (JSE:WHL) is about to trade ex-dividend in the next four 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. Thus, you can purchase Woolworths Holdings' shares before the 25th of September in order to receive the dividend, which the company will pay on the 30th of September.

The company's next dividend payment will be R01.175 per share. Last year, in total, the company distributed R2.35 to shareholders. Calculating the last year's worth of payments shows that Woolworths Holdings has a trailing yield of 3.5% on the current share price of R066.54. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

Check out our latest analysis for Woolworths Holdings

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. Last year, Woolworths Holdings paid out 92% of its income as dividends, which is above a level that we're comfortable with, especially if the company needs to reinvest in its business. A useful secondary check can be to evaluate whether Woolworths Holdings generated enough free cash flow to afford its dividend. It paid out 97% of its free cash flow in the form of dividends last year, which is outside the comfort zone 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.

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

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

Have Earnings And Dividends Been Growing?

Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. It's encouraging to see Woolworths Holdings has grown its earnings rapidly, up 41% a year for the past five years. Woolworths Holdings'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. Woolworths Holdings's dividend payments per share have declined at 0.6% per year on average over the past 10 years, which is uninspiring.

The Bottom Line

Should investors buy Woolworths Holdings 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.

So if you're still interested in Woolworths Holdings despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. Our analysis shows 3 warning signs for Woolworths Holdings and you should be aware of these before buying any shares.

A common investing mistake is buying the first interesting stock you see. Here you can find a full list of high-yield 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.