Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Step One Clothing Limited (ASX:STP) is about to trade ex-dividend in the next 2 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 of consequence because whenever a stock is bought or sold, the trade takes at least two business day to settle. Meaning, you will need to purchase Step One Clothing's shares before the 24th of February to receive the dividend, which will be paid on the 14th of March.

The company's next dividend payment will be AU$0.044 per share, on the back of last year when the company paid a total of AU$0.068 to shareholders. Last year's total dividend payments show that Step One Clothing has a trailing yield of 6.5% on the current share price of AU$1.045. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. As a result, readers should always check whether Step One Clothing has been able to grow its dividends, or if the dividend might be cut.

See our latest analysis for Step One Clothing

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. Step One Clothing paid out a comfortable 39% of its profit last year. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. It paid out 92% of its free cash flow in the form of dividends last year, which is outside the comfort zone 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.

Step One Clothing paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Were this to happen repeatedly, this would be a risk to Step One Clothing's ability to maintain its dividend.

Click here to see how much of its profit Step One Clothing paid out over the last 12 months.

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 earnings fall far enough, the company could be forced to cut its dividend. It's encouraging to see Step One Clothing has grown its earnings rapidly, up 48% a year for the past five years. Earnings have been growing quickly, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

Given that Step One Clothing has only been paying a dividend for a year, there's not much of a past history to draw insight from.

Final Takeaway

Has Step One Clothing got what it takes to maintain its dividend payments? We like that Step One Clothing has been successfully growing its earnings per share at a nice rate and reinvesting most of its profits in the business. However, we note the high cashflow payout ratio with some concern. It might be worth researching if the company is reinvesting in growth projects that could grow earnings and dividends in the future, but for now we're not all that optimistic on its dividend prospects.

While it's tempting to invest in Step One Clothing for the dividends alone, you should always be mindful of the risks involved. For example, we've found 1 warning sign for Step One Clothing that we recommend you consider before investing in the business.

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.