Why it might not make sense to buy Southwest Gas Holdings, Inc. (NYSE:SWX) because of the upcoming dividend

Some investors rely on dividends to grow their wealth. If you are one of these dividend sleuths, you might be interested to know that Southwest Gas Holdings, Inc. (NYSE:SWX) will trade ex-dividend in just 2 days. Typically, the ex-dividend date occurs one business day before the record date, which is the day on which a company determines shareholders entitled to a dividend. The ex-dividend date is significant because trading takes at least two business days each time a share is bought or sold. Accordingly, Southwest Gas Holdings investors who purchase the stock on or after August 15 will not receive the dividend, which is paid on September 3.

The company’s next dividend payment will be $0.62 per share. Over the last 12 months, the company paid a total of $2.48 per share. Based on last year’s payments, Southwest Gas Holdings has a yield of 3.5% on the current share price of $71.47. Dividends are an important source of income for many shareholders, but the health of the company is critical to maintaining those dividends. We’ll need to see if the dividend is covered by earnings, and if it’s growing.

Check out our latest analysis for Southwest Gas Holdings

If a company pays out more in dividends than it earns, the dividend can become unsustainable – far from an ideal situation. Last year, Southwest Gas Holdings paid out 98% of its income as dividends, which is above a level we consider acceptable, especially when the company needs to reinvest in its business. However, cash flows are even more important than profits when assessing a dividend, so we need to look at whether the company generated enough cash to pay the distribution. Fortunately, it only paid out 38% of its free cash flow last year.

It’s good to see that while Southwest Gas Holdings’ dividends weren’t well covered by earnings, they’re at least affordable from a financial perspective. However, if the company continues to pay out such a high percentage of its earnings, the dividend could be at risk if business performs poorly.

Click here to see the company’s payout ratio as well as analyst estimates of its future dividends.

Have earnings and dividends increased?

Companies with declining earnings are tricky from a dividend perspective. If earnings fall and the company is forced to cut its dividend, investors could see the value of their investment go up in smoke. With that in mind, we’re concerned about Southwest Gas Holdings’ earnings decline of 7.2% per year over the past five years. Ultimately, when earnings per share fall, the size of the pie from which dividends can be paid shrinks.

Southwest Gas Holdings has also issued more than 5% of its market capitalization in the form of new shares over the past year, which we believe may hurt the company’s dividend prospects over the long term. It’s hard to grow dividends per share when a company is constantly issuing new shares.

Many investors judge a company’s dividend performance by how dividend payments have changed over time. Southwest Gas Holdings has increased its dividend by an average of 6.5% per year over the past decade. That’s interesting, but the combination of increasing dividends despite declining earnings can usually only be achieved by paying out a larger percentage of earnings. Southwest Gas Holdings already pays out a high percentage of its earnings, so without earnings growth, we doubt this dividend will increase much in the future.

The conclusion

Should investors buy or avoid Southwest Gas Holdings from a dividend perspective? It’s not a great combination to see a company with declining earnings paying out 98% of its earnings, which could mean the dividend could be cut in the future. However, the payout ratio has been much lower — good news from a dividend perspective — which makes us wonder why there is such a mismatch between earnings and cash flow. From a dividend perspective, this is not an attractive combination, and we’re inclined to pass on it for now.

However, if you are not put off by Southwest Gas Holdings’ poor dividend characteristics, you should be aware of the risks associated with this business. To this end, you should read about the 2 warning signs We found one at Southwest Gas Holdings (including 1 that is a little unpleasant).

A common mistake when investing is to buy the first interesting stock you see. Here you can find a complete list of high dividend stocks.

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This Simply Wall St article is of a general nature. We comment solely on the basis of historical data and analyst forecasts, using an unbiased methodology. Our articles do not constitute financial advice. It is not a recommendation to buy or sell any stock and does not take into account your objectives or financial situation. Our goal is to provide you with long-term analysis based on fundamental data. Note that our analysis may not take into account the latest price-sensitive company announcements or qualitative materials. Simply Wall St does not hold any of the stocks mentioned.