The board of Challenger Limited (ASX:CGF) has announced that it will be paying its dividend of A$0.135 on the 18th of September, an increased payment from last year's comparable dividend. Based on this payment, the dividend yield for the company will be 3.7%, which is fairly typical for the industry.

Check out our latest analysis for Challenger

Challenger's Dividend Is Well Covered By Earnings

We like a dividend to be consistent over the long term, so checking whether it is sustainable is important. Based on the last payment, Challenger's profits didn't cover the dividend, but the company was generating enough cash instead. Given that the dividend is a cash outflow, we think that cash is more important than accounting measures of profit when assessing the dividend, so this is a mitigating factor.

According to analysts, EPS should be several times higher next year. If recent patterns in the dividend continue, we could see the payout ratio reaching 37% which is fairly sustainable. historic-dividend

Dividend Volatility

Although the company has a long dividend history, it has been cut at least once in the last 10 years. Since 2014, the annual payment back then was A$0.20, compared to the most recent full-year payment of A$0.27. This works out to be a compound annual growth rate (CAGR) of approximately 3.0% a year over that time. Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.

The Dividend Has Limited Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share is growing, which could point to a growing dividend in the future. Challenger's EPS has fallen by approximately 17% per year during the past five years. Such rapid declines definitely have the potential to constrain dividend payments if the trend continues into the future. On the bright side, earnings are predicted to gain some ground over the next year, but until this turns into a pattern we wouldn't be feeling too comfortable.

Challenger's Dividend Doesn't Look Sustainable

Overall, we always like to see the dividend being raised, but we don't think Challenger will make a great income stock. The payments haven't been particularly stable and we don't see huge growth potential, but with the dividend well covered by cash flows it could prove to be reliable over the short term. We would probably look elsewhere for an income investment.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. For example, we've picked out 3 warning signs for Challenger that investors should know about before committing capital to this stock. If you are a dividend investor, you might also want to look at our curated list of high yield 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.