Here’s why we’re reluctant to buy Diversified Royalties (TSE: DIV) for its upcoming dividend

Diversified Royalty Corp. The stock (TSE: DIV) is about to trade off-dividend in four days. Typically, the ex-dividend date is one business day prior to the record date which is the date a company determines which shareholders are eligible to receive a dividend. The ex-dividend date is important because every time a stock is bought or sold, the transaction takes at least two business days to settle. This means that investors who buy Diversified Royalty shares from December 14th will not receive the dividend, which will be paid on December 31st.

The company’s upcoming dividend is C $ 0.018 per share, continuing the past 12 months when the company has distributed a total of C $ 0.20 per share to shareholders. Based on the value of last year’s payouts, Diversified Royalty has a return of 7.3% on the current share price of C $ 2.83. Dividends are a major contributor to returns on investment for long-term holders, but only if the dividend continues to be paid. Accordingly, readers should always check whether Diversified Royalty has been able to increase its dividends or whether the dividend could be reduced.

See our latest review for Diversified Royalty

If a company pays more dividends than it has earned, then the dividend could become unsustainable – which is not an ideal situation. Diversified Royalty paid 152% of the profits over the past year, which in our opinion is generally not viable unless there are mitigating features such as unusually high cash flow or a large cash balance. Having said that, even very profitable companies can sometimes not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by the cash flow. It has paid out 272% of its free cash flow as dividends over the past 12 months, which is worrying. It is quite difficult to pay more than what you earn, so we wonder how Diversified Royalty intends to continue funding this dividend, or if it might be forced to reduce the payment.

Cash is slightly more important than earnings from a dividend perspective, but given that Diversified Royalty’s payments were not well covered by earnings or cash flow, we would be concerned about the sustainability of this dividend.

Click here to view the company’s payout ratio, as well as analysts’ estimates of its future dividends.

TSX: DIV Historical dividend December 9, 2021

Have profits and dividends increased?

Companies with constantly increasing earnings per share usually make the best dividend-paying stocks because they generally find it easier to increase dividends per share. If profits fall enough, the company could be forced to cut its dividend. For this reason, we are pleased to see that Diversified Royalty’s earnings per share have grown by 14% per year over the past five years. It’s great to see earnings per share rising rapidly, but we’re troubled to see the company shed 152% of its earnings last year. We are concerned that fast-growing companies will catch fire by over-committing financially and see this as a yellow flag.

Many investors will assess a company’s dividend performance by evaluating how much dividend payments have changed over time. Since our data began seven years ago, Diversified Royalty has increased its dividend by around 1.3% per year on average. Earnings per share have grown much faster than dividends, potentially because Diversified Royalty is withholding more of its earnings to grow the business.

To sum up

Does Diversified Royalty have what it takes to maintain its dividend payments? While it is nice to see the earnings per share increase, we are curious as to how Diversified Royalty intends to continue to grow or maintain the dividend in a downturn given that it pays such a high percentage of its earnings and cash flow. It’s not the most attractive proposition from a dividend standpoint, and we would probably drop this one for now.

However, if you are still interested in diverse royalty and want to learn more about it, then knowing what the risks this title faces will be of great help. For example, Diversified Royalty has 3 warning signs (and 2 which are a bit disturbing) we think you should know about.

If you’re looking for dividend-paying stocks, we recommend checking out our list of the highest dividend-paying stocks with a yield above 2% and a dividend ahead.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.

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