Consider This Before Buying Chongqing Machinery & Electric Co., Ltd. (HKG:2722) For The 4.7% Dividend

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Dividend paying stocks like Chongqing Machinery & Electric Co., Ltd. (HKG:2722) tend to be popular with investors, and for good reason – some research shows that a significant amount of all stock market returns come from reinvested dividends. If you are hoping to live on your dividends, it’s important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you’ll find our analysis useful.

In this case, Chongqing Machinery & Electric likely looks attractive to dividend investors, given its 4.7% dividend yield and nine-year payment history. 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 Chongqing Machinery & Electric for its dividend, and we’ll go through these below.

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SEHK:2722 Historical Dividend Yield, April 30th 2019
SEHK:2722 Historical Dividend Yield, April 30th 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, then the dividend might become unsustainable – hardly an ideal situation. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 34% of Chongqing Machinery & Electric’s profits were paid out as dividends in the last 12 months. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

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, Chongqing Machinery & Electric paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

We update our data on Chongqing Machinery & Electric every 24 hours, so you can always get our latest analysis of its financial health, here.

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. Looking at the last decade of data, we can see that Chongqing Machinery & Electric paid its first dividend at least nine years ago. It’s good to see that Chongqing Machinery & Electric has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we’re concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was CN¥0.06 in 2010, compared to CN¥0.03 last year. The dividend has shrunk at around -7.4% a year during that period. Chongqing Machinery & Electric’s dividend has been cut sharply at least once, so it hasn’t fallen by -7.4% every year, but this is a decent approximation of the long term change.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it’s even more important to see if EPS are growing. Chongqing Machinery & Electric’s earnings per share are down -6.0% over the past year. That’s not great to see, but there could be a number of reasons for this. Should the decline continue, we would become concerned. We do note though, one year is too short a time to be drawing strong conclusions about a company’s future prospects.

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. First, we like Chongqing Machinery & Electric’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 per share have been in decline, and its dividend has been cut at least once in the past. With this information in mind, we think Chongqing Machinery & Electric may not be an ideal dividend stock.

Are management backing themselves to deliver performance? Check their shareholdings in Chongqing Machinery & Electric in our latest insider ownership analysis.

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 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.