The Dividend Dilemma: How Unsustainable Dividends Are Funded
In the world of finance, dividends are a sign of strength — a reward to shareholders and a symbol of stability. But when a company’s payout exceeds its earnings or is funded by borrowing, the shine fades. Welcome to the Dividend Dilemma.
“A dividend paid from borrowed money is not a reward — it is a warning.”
The Illusion of Generosity
Investors love a rising dividend. But behind the curtain, companies may dip into reserves, take on debt, or sell assets to keep the illusion alive. Dividend payout ratios above 100% and negative free cash flow are early clues.
Real-World Examples of Dividend Trouble
| Company | Year | Dividend Payout Ratio | Red Flag |
|---|---|---|---|
| General Electric | 2017 | >100% | Dividends funded despite declining earnings and rising debt |
| Vodafone | 2019 | 133% | Cut dividend after years of funding payouts with debt |
| Bombardier | 2015 | >150% | Suspended dividend after borrowing to fund payouts |
Forensic Tool: Free Cash Flow Coverage Ratio
FCF Coverage Ratio = Free Cash Flow / Dividends Paid
A ratio below 1 indicates that the company is not generating enough free cash to sustainably cover its dividend. Ratios far below 1 are flashing red lights.
📊 Free Cash Flow vs Dividend Paid – Sustainability or Stretch?
Classic Red Flags to Investigate
| Red Flag | Surface Narrative | What Might Be Happening |
|---|---|---|
| Dividend Hikes in Loss Years | “Commitment to shareholders” | Funded by borrowing or asset sales |
| Constant High Payout Ratios | “Reliable income stock” | Business not reinvesting in growth |
| Negative Free Cash Flow | “One-off capex or working capital spike” | Dividends may be funded unsustainably |
Detective’s Note 🕵️
- Always cross-check dividend history with free cash flow trends.
- Use the FCF Coverage Ratio to assess sustainability.
- Watch out for companies maintaining dividends despite losses or rising debt.
- Reliable dividends come from reliable operations — not creative financing.
“There is nothing more deceptive than an obvious fact.\” – Sherlock Holmes