Don't Buy Advance Auto Parts, Inc. (NYSE:AAP) For Its Next Dividend Without Doing These Checks

It looks like Advance Auto Parts, Inc. (NYSE:AAP) is about to go ex-dividend in the next 3 days. The ex-dividend date is one business day before a company's record date, which is the date on which the company determines which shareholders are entitled to receive a dividend. The ex-dividend date is important as the process of settlement involves a full business day. So if you miss that date, you would not show up on the company's books on the record date. In other words, investors can purchase Advance Auto Parts' shares before the 9th of October in order to be eligible for the dividend, which will be paid on the 23rd of October.

The company's next dividend payment will be US$0.25 per share, on the back of last year when the company paid a total of US$1.00 to shareholders. Last year's total dividend payments show that Advance Auto Parts has a trailing yield of 2.6% on the current share price of US$38.68. If you buy this business for its dividend, you should have an idea of whether Advance Auto Parts's dividend is reliable and sustainable. So we need to check whether the dividend payments are covered, and if earnings are growing.

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If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Advance Auto Parts paid out 55% of its earnings to investors last year, a normal payout level for most businesses. A useful secondary check can be to evaluate whether Advance Auto Parts generated enough free cash flow to afford its dividend. Over the last year, it paid out dividends equivalent to 261% of what it generated in free cash flow, a disturbingly high percentage. Unless there were something in the business we're not grasping, this could signal a risk that the dividend may have to be cut in the future.

Advance Auto Parts paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Advance Auto Parts to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Check out our latest analysis for Advance Auto Parts

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

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. With that in mind, we're discomforted by Advance Auto Parts's 24% per annum decline in earnings in the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the last 10 years, Advance Auto Parts has lifted its dividend by approximately 15% a year on average. That's interesting, but the combination of a growing dividend despite declining earnings can typically only be achieved by paying out more of the company's profits. This can be valuable for shareholders, but it can't go on forever.

To Sum It Up

Should investors buy Advance Auto Parts for the upcoming dividend? It's definitely not great to see earnings per share shrinking. The company paid out an acceptable percentage of its income, but an uncomfortably high percentage of its cash flow over the past year. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

So if you're still interested in Advance Auto Parts despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. Our analysis shows 2 warning signs for Advance Auto Parts and you should be aware of these before buying any 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.