Epsilon Energy Ltd. (NASDAQ:EPSN) is about to trade ex-dividend in the next four days. The ex-dividend date is one business day before the record date, which is the cut-off date for shareholders to be present on the company's books to be eligible for a dividend payment. 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. In other words, investors can purchase Epsilon Energy's shares before the 14th of March in order to be eligible for the dividend, which will be paid on the 29th of March.

The company's next dividend payment will be US$0.0625 per share. Last year, in total, the company distributed US$0.25 to shareholders. Looking at the last 12 months of distributions, Epsilon Energy has a trailing yield of approximately 5.0% on its current stock price of US$4.99. 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 Epsilon 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. That's why it's good to see Epsilon Energy paying out a modest 41% of its earnings. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. Epsilon Energy paid out more free cash flow than it generated - 118%, to be precise - last year, which we think is concerningly high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Epsilon Energy does have a large net cash position on the balance sheet, which could fund large dividends for a time, if the company so chose. Still, smart investors know that it is better to assess dividends relative to the cash and profit generated by the business. Paying dividends out of cash on the balance sheet is not long-term sustainable.

Epsilon Energy paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Epsilon Energy to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Click here to see how much of its profit Epsilon Energy paid out over the last 12 months.

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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Fortunately for readers, Epsilon Energy's earnings per share have been growing at 17% a year for the past five years. Earnings have been growing at a decent rate, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. It looks like the Epsilon Energy dividends are largely the same as they were two years ago.

To Sum It Up

From a dividend perspective, should investors buy or avoid Epsilon Energy? We like that Epsilon Energy has been successfully growing its earnings per share at a nice rate and reinvesting most of its profits in the business. However, we note the high cashflow payout ratio with some concern. To summarise, Epsilon Energy looks okay on this analysis, although it doesn't appear a stand-out opportunity.

On that note, you'll want to research what risks Epsilon Energy is facing. To help with this, we've discovered 1 warning sign for Epsilon Energy that you should be aware of before investing in their shares.

Generally, we wouldn't recommend just buying the first dividend stock you see. Here's a curated list of interesting stocks that are strong dividend payers.

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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.