It looks like Smartgroup Corporation Ltd (ASX:SIQ) is about to go ex-dividend in the next 4 days. The ex-dividend date is two business days before a company's record date in most cases, which is the date on which the company determines which shareholders are entitled to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade can take two business days or more to settle. Thus, you can purchase Smartgroup's shares before the 6th of March in order to receive the dividend, which the company will pay on the 21st of March.

The company's upcoming dividend is AU$0.31 a share, following on from the last 12 months, when the company distributed a total of AU$0.51 per share to shareholders. Looking at the last 12 months of distributions, Smartgroup has a trailing yield of approximately 6.1% on its current stock price of AU$8.39. 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 investigate whether Smartgroup can afford its dividend, and if the dividend could grow.

Check out our latest analysis for Smartgroup

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. Smartgroup paid out more than half (64%) of its earnings last year, which is a regular payout ratio for most companies. 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 90% of its free cash flow in the form of dividends last year, which is outside the comfort zone for most businesses. Cash flows are usually much more volatile than earnings, so this could be a temporary effect - but we'd generally want to look more closely here.

While Smartgroup's dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Smartgroup to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. 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 Smartgroup, with earnings per share up 4.1% on average over the last five years. Earnings have been growing somewhat, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the past 10 years, Smartgroup has increased its dividend at approximately 24% a year on average. We're glad to see dividends rising alongside earnings over a number of years, which may be a sign the company intends to share the growth with shareholders.

Final Takeaway

Has Smartgroup got what it takes to maintain its dividend payments? Smartgroup is paying out a reasonable percentage of its income and an uncomfortably high 90% of its cash flow as dividends. At least earnings per share have been growing steadily. With the way things are shaping up from a dividend perspective, we'd be inclined to steer clear of Smartgroup.

With that in mind though, if the poor dividend characteristics of Smartgroup don't faze you, it's worth being mindful of the risks involved with this business. For example - Smartgroup has 1 warning sign we think you should be aware of.

A common investing mistake is buying the first interesting stock you see. Here you can find a full list of high-yield 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.