Readers hoping to buy Exchange Income Corporation (TSE:EIF) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. Ex-dividend means that investors that purchase the stock on or after the 28th of January will not receive this dividend, which will be paid on the 15th of February.
Exchange Income’s upcoming dividend is CA$0.19 a share, following on from the last 12 months, when the company distributed a total of CA$2.28 per share to shareholders. Last year’s total dividend payments show that Exchange Income has a trailing yield of 6.0% on the current share price of CA$37.88. 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.
Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. Exchange Income distributed an unsustainably high 198% 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. The company paid out 90% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Companies usually need cash more than they need earnings – expenses don’t pay themselves – so it’s not great to see it paying out so much of its cash flow.
Cash is slightly more important than profit from a dividend perspective, but given Exchange Income’s payouts were not well covered by either earnings or cash flow, we would be concerned about the sustainability of this dividend.
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. With that in mind, we’re encouraged by the steady growth at Exchange Income, with earnings per share up 3.8% on average over the last five years. Earnings are not growing much and Exchange Income paid out a lot more than it earned in profit last year. This makes the dividend look potentially unsustainable in the long run.
We’d also point out that Exchange Income issued a meaningful number of new shares in the past year. It’s hard to grow dividends per share when a company keeps creating new shares.
The main way most investors will assess a company’s dividend prospects is by checking the historical rate of dividend growth. Since the start…
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