I am trying to figure out how companies can distribute an annual dividend that is higher than their earnings per share.
If a company is not earning what they are paying out in dividends, there are other sources they could be using to fund it. They could take on more debt either from a bank loan or issue debt. There could be cash from the sale of assets or the reported earnings could be reduced by some accounting deduction and therefore real dollars could be higher.
Over the long term, free cash flow (cash flow from operations less capital expenses less dividends) is the most reliable measure of dividend sustainability. If a company is not able to fund its capital expenses and dividends from cash flow from operations, then this could be also an indication of a future dividend cut or issuance of additional shares.
It definitely warrants further research to prepare for a possible cut of the dividend. Invest with caution.
Nancy Woods, CIM, FCSI, is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. To ask her a question, send an e-mail to firstname.lastname@example.org or visit her web site at nancywoods.com
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