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 Royalty Pharma plc (NASDAQ:RPRX) is about to go ex-dividend in just 3 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 as the process of settlement involves a full business day. So if you miss that date, you would not show up on the company's books on the record date. Accordingly, Royalty Pharma investors that purchase the stock on or after the 14th of August will not receive the dividend, which will be paid on the 10th of September.

The company's next dividend payment will be US$0.235 per share. Last year, in total, the company distributed US$0.94 to shareholders. Based on the last year's worth of payments, Royalty Pharma stock has a trailing yield of around 1.7% on the current share price of US$56.77. We love seeing companies pay a dividend, but it's also important to be sure that laying the golden eggs isn't going to kill our golden goose! So we need to investigate whether Royalty Pharma can afford its dividend, and if the dividend could grow.

Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Royalty Pharma paid out a comfortable 49% of its profit last year. 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 69% of its free cash flow as dividends, within the usual range for most companies.

It's positive to see that Royalty Pharma's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

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

Have Earnings And Dividends Been Growing?

Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. If earnings fall far enough, the company could be forced to cut its dividend. This is why it's a relief to see Royalty Pharma earnings per share are up 6.7% per annum over the last five years. Decent historical earnings per share growth suggests Royalty Pharma has been effectively growing value for shareholders. However, it's now paying out more than half its earnings as dividends. Therefore it's unlikely that the company will be able to reinvest heavily in its business, which could presage slower growth in the future.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. Royalty Pharma has delivered 7.8% dividend growth per year on average over the past six 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 Royalty Pharma? Earnings per share have been growing at a steady rate, and Royalty Pharma paid out less than half its profits and more than half its free cash flow as dividends over the last year. It might be worth researching if the company is reinvesting in growth projects that could grow earnings and dividends in the future, but for now we're not all that optimistic on its dividend prospects.

In light of that, while Royalty Pharma has an appealing dividend, it's worth knowing the risks involved with this stock.

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

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.