Atlas Copco AB (STO:ATCO A) is set to trade ex-dividend in the next 3 days. The ex-dividend date occurs one day before the record date which is the day shareholders must be on the books of the company to receive a dividend. The ex-dividend date is an important date to know because any purchase of shares made on or after this date may mean late settlement that does not appear on the record date. As a result, Atlas Copco investors who buy the shares on or after October 20 will not receive the dividend, which will be paid on October 26.

The company’s next dividend payment will be 0.95 kr per share, after last year when the company paid a total of 1.90 kr to shareholders. Last year’s total dividend payout shows Atlas Copco yielding 1.8% on the current share price of SEK 105.56. We love to see companies pay out a dividend, but it’s also important to make sure that laying the golden eggs doesn’t kill our golden hen! We need to see if the dividend is covered by earnings and if it increases.

Our analysis indicates that ATCO A is potentially undervalued!

Dividends are usually paid out of company earnings, so if a company pays out more than it has earned, its dividend is usually at risk of being reduced. Atlas Copco paid out a comfortable 46% of its profit last year. Still, cash flow is usually more important than earnings in assessing the sustainability of dividends, so we always need to check whether the company has generated enough cash to pay its dividend. It has paid out more than half (54%) of its free cash flow in the past year, which is in the middle range for most companies.

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

Click here to see the company’s payout ratio, as well as analysts’ estimates of its future dividends.

Have earnings and dividends increased?

Companies with consistently rising earnings per share tend to create the best dividend-paying stocks because they generally find it easier to increase dividends per share. Investors love dividends, so if earnings fall and the dividend is cut, expect a stock to sell strongly at the same time. With this in mind, we are encouraged by Atlas Copco’s steady growth, with earnings per share up 8.1% on average over the past five years. The decent historic growth in earnings per share suggests that Atlas Copco has indeed increased shareholder value. However, it now pays more than half of its profits in the form of dividends. If management raises the payout ratio further, we’ll take that as a tacit signal that the company’s growth prospects are slowing.

Many investors will gauge a company’s dividend yield by evaluating how much dividend payouts have changed over time. Since our data began 10 years ago, Atlas Copco has increased its dividend by about 4.3% per year on average. We are pleased to see dividends rising alongside earnings over several years, which may be a sign that the company intends to share the growth with shareholders.

Last takeaway

From a dividend perspective, should investors buy or avoid Atlas Copco? Earnings per share have grown at a steady pace and Atlas Copco has paid out less than half of its earnings and more than half of its free cash flow in dividends over the past year. In summary, although it has some positive characteristics, we are not inclined to rush to buy Atlas Copco today.

Want to know what other investors think of Atlas Copco? See analyst forecasts with this visualization of its historical and future estimated earnings and cash flow.

A common investment mistake is to buy the first good stock you see. Here you can find a complete list of high yielding dividend stocks.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.