Readers hoping to buy Valero Energy Corporation (NYSE:VLO) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. 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. Therefore, if you purchase Valero Energy's shares on or after the 20th of November, you won't be eligible to receive the dividend, when it is paid on the 20th of December.

The company's upcoming dividend is US$1.07 a share, following on from the last 12 months, when the company distributed a total of US$4.28 per share to shareholders. Based on the last year's worth of payments, Valero Energy has a trailing yield of 3.1% on the current stock price of US$140.02. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether Valero Energy can afford its dividend, and if the dividend could grow.

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. Fortunately Valero Energy's payout ratio is modest, at just 38% of profit. A useful secondary check can be to evaluate whether Valero Energy generated enough free cash flow to afford its dividend. Luckily it paid out just 23% of its free cash flow last year.

It's positive to see that Valero Energy'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?

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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. This is why it's a relief to see Valero Energy earnings per share are up 9.7% per annum over the last five years. Management have been reinvested more than half of the company's earnings within the business, and the company has been able to grow earnings with this retained capital. Organisations that reinvest heavily in themselves typically get stronger over time, which can bring attractive benefits such as stronger earnings and dividends.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Valero Energy has delivered 16% dividend growth per year on average over the past 10 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 Valero Energy? Earnings per share have been growing moderately, and Valero Energy is paying out less than half its earnings and cash flow as dividends, which is an attractive combination as it suggests the company is investing in growth. We would prefer to see earnings growing faster, but the best dividend stocks over the long term typically combine significant earnings per share growth with a low payout ratio, and Valero Energy is halfway there. Valero Energy looks solid on this analysis overall, and we'd definitely consider investigating it more closely.

On that note, you'll want to research what risks Valero Energy is facing. Every company has risks, and we've spotted 2 warning signs for Valero Energy (of which 1 is significant!) you should know about.

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

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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.