Some investors rely on dividends for growing their wealth, and if you're one of those dividend sleuths, you might be intrigued to know that Wesfarmers Limited (ASX:WES) is about to go ex-dividend in just day or two. The ex-dividend date is usually set to be one business day before the record date which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the 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. Therefore, if you purchase Wesfarmers' shares on or after the 1st of September, you won't be eligible to receive the dividend, when it is paid on the 7th of October.

The company's next dividend payment will be AU$0.90 per share. Last year, in total, the company distributed AU$1.80 to shareholders. Calculating the last year's worth of payments shows that Wesfarmers has a trailing yield of 2.9% on the current share price of A$62.2. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. We need to see whether the dividend is covered by earnings and if it's growing.

See our latest analysis for Wesfarmers

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. It paid out 85% 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. We'd be concerned if earnings began to decline. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. Over the last year, it paid out more than three-quarters (75%) 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. That's why it's comforting to see Wesfarmers's earnings have been skyrocketing, up 42% per annum for the past five years. Earnings per share are growing at a rapid rate, yet the company is paying out more than three-quarters of its earnings.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Wesfarmers has delivered an average of 3.4% per year annual increase in its dividend, based on the past 10 years of dividend payments. It's good to see both earnings and the dividend have improved - although the former has been rising much quicker than the latter, possibly due to the company reinvesting more of its profits in growth.

Final Takeaway

Is Wesfarmers worth buying for its dividend? It's good to see earnings are growing, since all of the best dividend stocks grow their earnings meaningfully over the long run. However, we'd also note that Wesfarmers is paying out more than half of its earnings and cash flow as profits, which could limit the dividend growth if earnings growth slows. In summary, it's hard to get excited about Wesfarmers from a dividend perspective.

While it's tempting to invest in Wesfarmers for the dividends alone, you should always be mindful of the risks involved. Our analysis shows 1 warning sign for Wesfarmers and you should be aware of this before buying any shares.

If you're in the market for dividend stocks, we recommend checking our list of top dividend stocks with a greater than 2% yield and an upcoming dividend.

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 (at) simplywallst.com.