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It Might Not Be A Great Idea To Buy Challenger Limited (ASX:CGF) For Its Next Dividend

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Challenger Limited (ASX:CGF) is about to trade ex-dividend in the next three days. The ex-dividend date occurs one day before the record date which is the day on which shareholders need to be on the company's books in order to receive a dividend. The ex-dividend date is important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. Thus, you can purchase Challenger's shares before the 21st of February in order to receive the dividend, which the company will pay on the 21st of March.

The company's next dividend payment will be AU$0.12 per share. Last year, in total, the company distributed AU$0.24 to shareholders. Based on the last year's worth of payments, Challenger has a trailing yield of 3.2% on the current stock price of A$7.39. We love seeing companies pay a dividend, but it's also important to be sure that laying the golden eggs isn't going to kill our golden goose! We need to see whether the dividend is covered by earnings and if it's growing.

Check out our latest analysis for Challenger

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Challenger paid out 167% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance.

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When the dividend payout ratio is high, as it is in this case, the dividend is usually at greater risk of being cut in the future.

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

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historic-dividend

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. With that in mind, we're discomforted by Challenger's 28% per annum decline in earnings in the past 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. Challenger has delivered an average of 3.5% per year annual increase in its dividend, based on the past 10 years of dividend payments. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Challenger is already paying out 167% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

Has Challenger got what it takes to maintain its dividend payments? Earnings per share are in decline and Challenger is paying out what we feel is an uncomfortably high percentage of its profit as dividends. It's not that we hate the business, but we feel that these characeristics are not desirable for investors seeking a reliable dividend stock to own for the long term. These characteristics don't generally lead to outstanding dividend performance, and investors may not be happy with the results of owning this stock for its dividend.

Although, if you're still interested in Challenger and want to know more, you'll find it very useful to know what risks this stock faces. To help with this, we've discovered 2 warning signs for Challenger that you should be aware of before investing in their shares.

Generally, we wouldn't recommend just buying the first dividend stock you see. Here's a curated list of interesting stocks that are strong dividend payers.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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