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Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see McChip Resources Inc. (CVE:MCS) is about to trade ex-dividend in the next 4 days. You will need to purchase shares before the 13th of January to receive the dividend, which will be paid on the 21st of January.
McChip Resources's next dividend payment will be CA$0.04 per share, which looks like a nice increase on last year, when the company distributed a total of CA$0.02 to shareholders. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to check whether the dividend payments are covered, and if earnings are growing.
Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. McChip Resources is paying out just 8.3% of its profit after tax, which is comfortably low and leaves plenty of breathing room in the case of adverse events. A useful secondary check can be to evaluate whether McChip Resources generated enough free cash flow to afford its dividend. Dividends consumed 65% of the company's free cash flow last year, which is within a normal range for most dividend-paying organisations.
It's positive to see that McChip Resources's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Have Earnings And Dividends Been Growing?
Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. This is why it's a relief to see McChip Resources earnings per share are up 7.1% per annum over the last five years. Decent historical earnings per share growth suggests McChip Resources has been effectively growing value for shareholders. However, it's now paying out more than half its earnings as dividends. Therefore it's unlikely that the company will be able to reinvest heavily in its business, which could presage slower growth in the future.
Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. McChip Resources has seen its dividend decline 15% per annum on average over the past 10 years, which is not great to see. It's unusual to see earnings per share increasing at the same time as dividends per share have been in decline. We'd hope it's because the company is reinvesting heavily in its business, but it could also suggest business is lumpy.
The Bottom Line
From a dividend perspective, should investors buy or avoid McChip Resources? Earnings per share growth has been modest, and it's interesting that McChip Resources is paying out less than half of its earnings and more than half its cash flow to shareholders in the form of dividends. In summary, while it has some positive characteristics, we're not inclined to race out and buy McChip Resources today.
While it's tempting to invest in McChip Resources for the dividends alone, you should always be mindful of the risks involved. To help with this, we've discovered 5 warning signs for McChip Resources (3 make us uncomfortable!) that you ought to be aware of before buying the shares.
We wouldn't recommend just buying the first dividend stock you see, though. Here's a list of interesting dividend stocks with a greater than 2% yield and an upcoming dividend.
This article by Simply Wall St is general in nature. 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.
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