Do Investors Have Good Reason To Be Wary Of Falcon Minerals Corporation's (NASDAQ:FLMN) 8.6% Dividend Yield?

Is Falcon Minerals Corporation (NASDAQ:FLMN) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

Falcon Minerals has only been paying a dividend for a year or so, so investors might be curious about its 8.6% yield. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 179% of Falcon Minerals's profits were paid out as dividends in the last 12 months. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. The company paid out 64% of its free cash flow, which is not bad per se, but does start to limit the amount of cash Falcon Minerals has available to meet other needs. It's good to see that while Falcon Minerals's dividends were not covered by profits, at least they are affordable from a cash perspective. 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.

Is Falcon Minerals's Balance Sheet Risky?

As Falcon Minerals's dividend was not well covered by earnings, we need to check its balance sheet for signs of financial distress. A quick check of its financial situation can be done with two ratios: net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Falcon Minerals has net debt of 0.56 times its EBITDA, which we think is not too troublesome.

We calculated its interest cover by measuring its earnings before interest and tax (EBIT), and dividing this by the company's net interest expense. With EBIT of 19.32 times its interest expense, Falcon Minerals's interest cover is quite strong - more than enough to cover the interest expense.

Remember, you can always get a snapshot of Falcon Minerals's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. This company has been paying a dividend for less than 2 years, which we think is too soon to consider it a reliable dividend stock. This works out to a decline of approximately 40% over that time.

A shrinking dividend over a one-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. We're not keen on the fact that Falcon Minerals paid out such a high percentage of its income, although its cashflow is in better shape. Second, the company has not been able to generate earnings growth, and its history of dividend payments is shorter than we consider ideal (from a reliability perspective). With this information in mind, we think Falcon Minerals may not be an ideal dividend stock.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.