Dividend paying stocks like Shanghai Electric Group Company Limited (HKG:2727) tend to be popular with investors, and for good reason – some research suggests a significant amount of all stock market returns come from reinvested dividends. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company’s dividend doesn’t live up to expectations.
So you may wish to consider our analysis of Shanghai Electric Group’s financial health, here.
A 2.8% yield is nothing to get excited about, but investors probably think the long payment history suggests Shanghai Electric Group has some staying power. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.
Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable – hardly an ideal situation. So we need to form a view on if a company’s dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 30% of Shanghai Electric Group’s profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Plus, there is room to increase the payout ratio over time.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Last year, Shanghai Electric Group paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
With a strong net cash balance, Shanghai Electric Group investors may not have much to worry about in the near term from a dividend perspective.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well – nasty. For the purpose of this article, we only scrutinise the last decade of Shanghai Electric Group’s dividend payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was CN¥0.061 in 2009, compared to CN¥0.061 last year. Its dividends have grown at less than 1% per annum over this time frame.
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.
Dividend Growth Potential
With a relatively unstable dividend, it’s even more important to evaluate if earnings per share (EPS) are growing – it’s not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Shanghai Electric Group’s EPS are effectively flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. Shanghai Electric Group is paying out less than half of its earnings, which we like. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?
To summarise, shareholders should always check that Shanghai Electric Group’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we like Shanghai Electric Group’s low dividend payout ratio, although we’re a bit concerned that it paid out a substantially higher percentage of its free cash flow. Second, earnings have been essentially flat, and its history of dividend payments is chequered – having cut its dividend at least once in the past. Ultimately, Shanghai Electric Group comes up short on our dividend analysis. It’s not that we think it is a bad company – just that there are likely more appealing dividend prospects out there on this analysis.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 6 Shanghai Electric Group analysts we track are forecasting continued growth with our free report on analyst estimates for the company.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.