Downer EDI Limited (ASX:DOW) is about to trade ex-dividend in the next two 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. Meaning, you will need to purchase Downer EDI's shares before the 13th of September to receive the dividend, which will be paid on the 15th of October.

The company's next dividend payment will be AU$0.11 per share. Last year, in total, the company distributed AU$0.17 to shareholders. Based on the last year's worth of payments, Downer EDI has a trailing yield of 3.1% on the current stock price of AU$5.55. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. We need to see whether the dividend is covered by earnings and if it's growing.

View our latest analysis for Downer EDI

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. Downer EDI paid out a disturbingly high 203% of its profit as dividends last year, which makes us concerned there's something we don't fully understand in the business. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. Fortunately, it paid out only 27% 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 Downer EDI 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. historic-dividend

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. If earnings fall far enough, the company could be forced to cut its dividend. Downer EDI's earnings per share have fallen at approximately 28% a year over the previous five years. Such a sharp decline casts doubt on the future sustainability of the dividend.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Downer EDI has seen its dividend decline 2.5% per annum on average over the past 10 years, which is not great to see. It's never nice to see earnings and dividends falling, but at least management has cut the dividend rather than potentially risk the company's health in an attempt to maintain it.

To Sum It Up

Is Downer EDI an attractive dividend stock, or better left on the shelf? It's never great to see earnings per share declining, especially when a company is paying out 203% 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 Downer EDI's cash flows, or perhaps the company has written down some assets aggressively, reducing its income. It's not that we think Downer EDI is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

Although, if you're still interested in Downer EDI and want to know more, you'll find it very useful to know what risks this stock faces. In terms of investment risks, we've identified 2 warning signs with Downer EDI and understanding them should be part of your investment process.

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.