Dividend paying stocks like Bank of Communications Co., Ltd. (HKG:3328) 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.
In this case, Bank of Communications likely looks attractive to investors, given its 8.2% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. Before you buy any stock for its dividend however, you should always remember Warren Buffett’s two rules: 1) Don’t lose money, and 2) Remember rule #1. We’ll run through some checks below to help with this.
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Payout ratios
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. Bank of Communications paid out 32% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
Remember, you can always get a snapshot of Bank of Communications’ latest financial position, by checking our visualisation of its financial health.
Dividend Volatility
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 Bank of Communications’ dividend payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was CN¥0.2 in 2010, compared to CN¥0.3 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.7% a year over that time. Bank of Communications’ dividend payments have fluctuated, so it hasn’t grown 5.7% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.
Dividends have grown at a reasonable rate, but with at least one substantial cut in the payments, we’re not certain this dividend stock would be ideal for someone intending to live on the income.
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. Bank of Communications’ earnings per share have been essentially flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company’s dividends could be eroded by inflation. A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?
We’d also point out that Bank of Communications issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus – perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.
Conclusion
Dividend investors should always want to know if a) a company’s dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. We’re glad to see Bank of Communications has a low payout ratio, as this suggests earnings are being reinvested in the business. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. In summary, we’re unenthused by Bank of Communications as a dividend stock. It’s not that we think it is a bad company; it simply falls short of our criteria in some key areas.
Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. However, there are other things to consider for investors when analysing stock performance. For example, we’ve picked out 1 warning sign for Bank of Communications that investors should know about before committing capital to this stock.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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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. 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.
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