Dividend paying stocks like CNOOC Limited (HKG:883) 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. 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, CNOOC likely looks attractive to investors, given its 7.9% 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.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 64% of CNOOC's profits were paid out as dividends in the last 12 months. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, CNOOC paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
With a strong net cash balance, CNOOC investors may not have much to worry about in the near term from a dividend perspective.
We update our data on CNOOC every 24 hours, so you can always get our latest analysis of its financial health, here.
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. For the purpose of this article, we only scrutinise the last decade of CNOOC's dividend payments. Its dividend payments have declined on at least one occasion over the past 10 years. During the past 10-year period, the first annual payment was CN¥0.3 in 2011, compared to CN¥0.5 last year. This works out to be a compound annual growth rate (CAGR) of approximately 4.5% a year over that time. CNOOC's dividend payments have fluctuated, so it hasn't grown 4.5% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.
It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.
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. CNOOC's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation.
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 think CNOOC has an acceptable payout ratio, although its dividend was not well covered by cashflow. Earnings per share are down, and CNOOC's dividend has been cut at least once in the past, which is disappointing. In this analysis, CNOOC doesn't shape up too well as a dividend stock. We'd find it hard to look past the flaws, and would not be inclined to think of it as a reliable dividend-payer.
Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For instance, we've picked out 1 warning sign for CNOOC that investors should take into consideration.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 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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