Could China Machinery Engineering Corporation (HKG:1829) Have The Makings Of Another Dividend Aristocrat?

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we'll take a closer look at China Machinery Engineering Corporation (HKG:1829) from a dividend investor's perspective. Owning a strong dividend company and reinvesting the dividends is widely seen as an attractive way of growing your wealth. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a six-year payment history and a 6.3% yield, many investors probably find China Machinery Engineering intriguing. It sure looks interesting on these metrics - but there's always more to the story . There are a few simple ways to reduce the risks of buying China Machinery Engineering for its dividend, and we'll go through these below.

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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. China Machinery Engineering paid out 40% of its profit as dividends, over the trailing twelve month period. 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. With a cash payout ratio of 568%, China Machinery Engineering's dividend payments are poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely.

With a strong net cash balance, China Machinery Engineering investors may not have much to worry about in the near term from a dividend perspective.

Remember, you can always get a snapshot of China Machinery Engineering's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Looking at the data, we can see that China Machinery Engineering has been paying a dividend for the past six years. The dividend has been quite stable over the past six years, which is great to see - although we usually like to see the dividend maintained for a decade before giving it full marks, though. During the past six-year period, the first annual payment was CN¥0.16 in 2013, compared to CN¥0.21 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.0% a year over that time.

We like that the dividend hasn't been shrinking. However we're conscious that the company hasn't got an overly long track record of dividend payments yet, which makes us wary of relying on its dividend income.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. China Machinery Engineering has grown its earnings per share at 1.7% per annum over the past five years. China Machinery Engineering 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?

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. China Machinery Engineering has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Unfortunately, earnings growth has also been mediocre, and we think it has not been paying dividends long enough to demonstrate resilience across economic cycles. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than China Machinery Engineering out there.

Given that earnings are not growing, the dividend does not look nearly so attractive. Businesses can change though, and we think it would make sense to see what analysts are forecasting for the company.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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 editorial-team@simplywallst.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.