Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Paychex, Inc. (NASDAQ:PAYX) is about to trade ex-dividend in the next four days. Typically, the ex-dividend date is one business day 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 important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. Thus, you can purchase Paychex's shares before the 8th of August in order to receive the dividend, which the company will pay on the 29th of August.

The company's next dividend payment will be US$0.98 per share. Last year, in total, the company distributed US$3.92 to shareholders. Last year's total dividend payments show that Paychex has a trailing yield of 3.1% on the current share price of US$127.28. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. It paid out 78% of its earnings as dividends last year, which is not unreasonable, but limits reinvestment in the business and leaves the dividend vulnerable to a business downturn. It could become a concern if earnings started to decline. A useful secondary check can be to evaluate whether Paychex generated enough free cash flow to afford its dividend. Over the last year, it paid out more than three-quarters (76%) of its free cash flow generated, which is fairly high and may be starting to limit reinvestment in the business.

It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

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

Have Earnings And Dividends Been Growing?

Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. For this reason, we're glad to see Paychex's earnings per share have risen 10% per annum over the last five years. The company paid out most of its earnings as dividends over the last year, even though business is booming and earnings per share are growing rapidly. We're surprised that management has not elected to reinvest more in the business to accelerate growth further.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the past 10 years, Paychex has increased its dividend at approximately 11% a year on average. It's exciting to see that both earnings and dividends per share have grown rapidly over the past few years.

To Sum It Up

From a dividend perspective, should investors buy or avoid Paychex? Higher earnings per share generally lead to higher dividends from dividend-paying stocks over the long run. That's why we're glad to see Paychex's earnings per share growing, although as we saw, the company is paying out more than half of its earnings and cashflow - 78% and 76% respectively. Overall, it's hard to get excited about Paychex from a dividend perspective.

With that in mind, a critical part of thorough stock research is being aware of any risks that stock currently faces. For example - Paychex has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com