British American Tobacco p.l.c. (LON:BATS) stock is about to trade ex-dividend in four days. Typically, the ex-dividend date is two business days 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 can take two business days or more to settle. This means that investors who purchase British American Tobacco's shares on or after the 27th of March will not receive the dividend, which will be paid on the 7th of May.

The company's next dividend payment will be UK£0.6006 per share, and in the last 12 months, the company paid a total of UK£2.40 per share. Based on the last year's worth of payments, British American Tobacco has a trailing yield of 7.6% on the current stock price of UK£31.62. 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! So we need to investigate whether British American Tobacco can afford its dividend, and if the dividend could grow.

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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. British American Tobacco distributed an unsustainably high 176% of its profit as dividends to shareholders last year. Without extenuating circumstances, we'd consider the dividend at risk of a cut. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. It paid out more than half (55%) of its free cash flow in the past year, which is within an average range for most companies.

It's good to see that while British American Tobacco's dividends were not covered by profits, at least they are affordable from a cash perspective. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

Check out our latest analysis for British American Tobacco

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

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If earnings fall far enough, the company could be forced to cut its dividend. Readers will understand then, why we're concerned to see British American Tobacco's earnings per share have dropped 11% a year over the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. Since the start of our data, 10 years ago, British American Tobacco has lifted its dividend by approximately 5.2% a year on average. 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. British American Tobacco is already paying out 176% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

Final Takeaway

Should investors buy British American Tobacco for the upcoming dividend? Earnings per share have been in decline, which is not encouraging. Additionally, British American Tobacco is paying out quite a high percentage of its earnings, and more than half its cash flow, so it's hard to evaluate whether the company is reinvesting enough in its business to improve its situation. Overall it doesn't look like the most suitable dividend stock for a long-term buy and hold investor.

Although, if you're still interested in British American Tobacco 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 3 warning signs for British American Tobacco 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.

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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.