Key Things To Watch Out For If You Are After Perfect Shape Medical Limited's (HKG:1830) 9.3% Dividend

Is Perfect Shape Medical Limited (HKG:1830) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

In this case, Perfect Shape Medical likely looks attractive to dividend investors, given its 9.3% dividend yield and eight-year payment history. We'd agree the yield does look enticing. Remember though, due to the recent spike in its share price, Perfect Shape Medical's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. 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. Looking at the data, we can see that 90% of Perfect Shape Medical's profits were paid out as dividends in the last 12 months. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Of the free cash flow it generated last year, Perfect Shape Medical paid out 30% as dividends, suggesting the dividend is affordable. It's positive to see that Perfect Shape Medical's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

With a strong net cash balance, Perfect Shape Medical investors may not have much to worry about in the near term from a dividend perspective.

Remember, you can always get a snapshot of Perfect Shape Medical's 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. The first recorded dividend for Perfect Shape Medical, in the last decade, was eight years ago. It's good to see that Perfect Shape Medical 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 eight-year period, the first annual payment was HK$0.03 in 2012, compared to HK$0.3 last year. This works out to be a compound annual growth rate (CAGR) of approximately 39% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

Perfect Shape Medical has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Perfect Shape Medical has grown its earnings per share at 22% per annum over the past five years. The company pays out most of its earnings as dividends, although with such rapid EPS growth, its possible the dividend is better covered than it looks. Still, we'd be cautious about extrapolating high growth too far out into the future.

Conclusion

To summarise, shareholders should always check that Perfect Shape Medical'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 think Perfect Shape Medical has an acceptable payout ratio and its dividend is well covered by cashflow. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Overall we think Perfect Shape Medical is an interesting dividend stock, although it could be better.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we've picked out 3 warning signs for Perfect Shape Medical that investors should take into consideration.

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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