Don't Buy Zhejiang Xinguang Pharmaceutical Co., Ltd. (SZSE:300519) For Its Next Dividend Without Doing These Checks

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Zhejiang Xinguang Pharmaceutical Co., Ltd. (SZSE:300519) is about to trade ex-dividend in the next four days. Typically, the ex-dividend date is one business day before the record date which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is an important date to be aware of as any purchase of the stock made on or after this date might mean a late settlement that doesn't show on the record date. This means that investors who purchase Zhejiang Xinguang Pharmaceutical's shares on or after the 29th of May will not receive the dividend, which will be paid on the 29th of May.

The company's upcoming dividend is CN¥0.40 a share, following on from the last 12 months, when the company distributed a total of CN¥0.40 per share to shareholders. Last year's total dividend payments show that Zhejiang Xinguang Pharmaceutical has a trailing yield of 3.1% on the current share price of CN¥12.70. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

Check out our latest analysis for Zhejiang Xinguang Pharmaceutical

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Last year, Zhejiang Xinguang Pharmaceutical paid out 100% of its income as dividends, which is above a level that we're comfortable with, especially if the company needs to reinvest in its business. 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. Zhejiang Xinguang Pharmaceutical paid out more free cash flow than it generated - 172%, to be precise - last year, which we think is concerningly high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.

Zhejiang Xinguang Pharmaceutical 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.

As Zhejiang Xinguang Pharmaceutical's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

Click here to see how much of its profit Zhejiang Xinguang Pharmaceutical paid out over the last 12 months.

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Readers will understand then, why we're concerned to see Zhejiang Xinguang Pharmaceutical's earnings per share have dropped 8.4% a year over the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. In the past seven years, Zhejiang Xinguang Pharmaceutical has increased its dividend at approximately 6.9% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. Zhejiang Xinguang Pharmaceutical is already paying out 100% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

Final Takeaway

Should investors buy Zhejiang Xinguang Pharmaceutical for the upcoming dividend? Not only are earnings per share declining, but Zhejiang Xinguang Pharmaceutical is paying out an uncomfortably high percentage of both its earnings and cashflow to shareholders as dividends. This is a starkly negative combination that often suggests a dividend cut could be in the company's near future. It's not that we think Zhejiang Xinguang Pharmaceutical is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

So if you're still interested in Zhejiang Xinguang Pharmaceutical despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. In terms of investment risks, we've identified 2 warning signs with Zhejiang Xinguang Pharmaceutical and understanding them should be part of your investment process.

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.