Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Innospec Inc. (NASDAQ:IOSP) is about to trade ex-dividend in the next three days. Typically, the ex-dividend date is one business day before the record date, which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is an important date to be aware of as any purchase of the stock made on or after this date might mean a late settlement that doesn't show on the record date. In other words, investors can purchase Innospec's shares before the 20th of May in order to be eligible for the dividend, which will be paid on the 30th of May.
The company's upcoming dividend is US$0.84 a share, following on from the last 12 months, when the company distributed a total of US$1.58 per share to shareholders. Looking at the last 12 months of distributions, Innospec has a trailing yield of approximately 1.8% on its current stock price of US$88.27. If you buy this business for its dividend, you should have an idea of whether Innospec's dividend is reliable and sustainable. So we need to investigate whether Innospec can afford its dividend, and if the dividend could grow.
Our free stock report includes 3 warning signs investors should be aware of before investing in Innospec. Read for free now.
If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Innospec distributed an unsustainably high 143% of its profit as dividends to shareholders last year. Without extenuating circumstances, we'd consider the dividend at risk of a cut. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. Over the last year it paid out 56% of its free cash flow as dividends, within the usual range for most companies.
It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Innospec 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. Very few companies are able to sustainably pay dividends larger than their reported earnings.
Businesses with shrinking earnings are tricky from a dividend perspective. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're discomforted by Innospec's 25% 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.
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, Innospec has lifted its dividend by approximately 11% a year on average. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Innospec is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.
To Sum It Up
Has Innospec got what it takes to maintain its dividend payments? Earnings per share have been shrinking in recent times. Additionally, Innospec is paying out quite a high percentage of its earnings, and more than half its cash flow, so it's hard to evaluate whether the company is reinvesting enough in its business to improve its situation. Bottom line: Innospec has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.
So if you're still interested in Innospec despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. In terms of investment risks, we've identified 3 warning signs with Innospec and understanding them should be part of your investment process.
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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.
