It looks like Microchip Technology Incorporated (NASDAQ:MCHP) is about to go ex-dividend in the next two days. The ex-dividend date is one business day before the record date, which is the cut-off date for shareholders to be present on the company's books to be eligible for a dividend payment. 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. This means that investors who purchase Microchip Technology's shares on or after the 22nd of November will not receive the dividend, which will be paid on the 6th of December.

The company's next dividend payment will be US$0.455 per share, on the back of last year when the company paid a total of US$1.82 to shareholders. Based on the last year's worth of payments, Microchip Technology stock has a trailing yield of around 2.8% on the current share price of US$65.25. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to check whether the dividend payments are covered, and if earnings are growing.

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. Microchip Technology distributed an unsustainably high 124% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. A useful secondary check can be to evaluate whether Microchip Technology generated enough free cash flow to afford its dividend. Over the last year it paid out 64% of its free cash flow as dividends, within the usual range for most companies.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Microchip Technology fortunately did generate enough cash to fund its dividend. 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.

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

Have Earnings And Dividends Been Growing?

Companies with consistently growing earnings per share generally make the best dividend stocks, as they usually find it easier to grow dividends per share. If business enters a downturn and the dividend is cut, the company could see its value fall precipitously. For this reason, we're glad to see Microchip Technology's earnings per share have risen 14% per annum over the last five years.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Microchip Technology has delivered 9.9% dividend growth per year on average over the past 10 years. It's encouraging to see the company lifting dividends while earnings are growing, suggesting at least some corporate interest in rewarding shareholders.

The Bottom Line

From a dividend perspective, should investors buy or avoid Microchip Technology? Growing earnings per share and a normal cashflow payout ratio is an ok combination, but we're concerned that the company is paying out such a high percentage of its income as dividends. Overall, it's not a bad combination, but we feel that there are likely more attractive dividend prospects out there.

With that being said, if dividends aren't your biggest concern with Microchip Technology, you should know about the other risks facing this business. For example - Microchip Technology has 3 warning signs we think you should be aware of.

If you're in the market for strong dividend payers, we recommend checking our selection of top dividend stocks.

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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.