Dividend Investors: Don't Be Too Quick To Buy Lam Soon (Hong Kong) Limited (HKG:411) For Its Upcoming Dividend

Lam Soon (Hong Kong) Limited (HKG:411) is about to trade ex-dividend in the next three days. The ex-dividend date is one business day before a company's record date, which is the date on which the company determines which shareholders are entitled to receive a dividend. It is important to be aware of the ex-dividend date because any trade on the stock needs to have been settled on or before the record date. This means that investors who purchase Lam Soon (Hong Kong)'s shares on or after the 16th of November will not receive the dividend, which will be paid on the 5th of December.

The company's next dividend payment will be HK$0.20 per share, on the back of last year when the company paid a total of HK$0.30 to shareholders. Based on the last year's worth of payments, Lam Soon (Hong Kong) stock has a trailing yield of around 3.8% on the current share price of HK$8. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. We need to see whether the dividend is covered by earnings and if it's growing.

View our latest analysis for Lam Soon (Hong Kong)

Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Its dividend payout ratio is 83% of profit, which means the company is paying out a majority of its earnings. The relatively limited profit reinvestment could slow the rate of future earnings growth. We'd be worried about the risk of a drop in earnings. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. It paid out 92% of its free cash flow in the form of dividends last year, which is outside the comfort zone for most businesses. Cash flows are usually much more volatile than earnings, so this could be a temporary effect - but we'd generally want to look more closely here.

While Lam Soon (Hong Kong)'s dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Cash is king, as they say, and were Lam Soon (Hong Kong) to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Click here to see how much of its profit Lam Soon (Hong Kong) paid out over the last 12 months.

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're discomforted by Lam Soon (Hong Kong)'s 23% per annum decline in earnings in the past five years. Such a sharp decline casts doubt on the future sustainability of the dividend.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the last 10 years, Lam Soon (Hong Kong) has lifted its dividend by approximately 9.6% 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. Lam Soon (Hong Kong) is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.

To Sum It Up

Should investors buy Lam Soon (Hong Kong) for the upcoming dividend? It's definitely not great to see earnings per share shrinking. The company paid out an acceptable percentage of its income, but an uncomfortably high percentage of its cash flow over the past year. Bottom line: Lam Soon (Hong Kong) has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with Lam Soon (Hong Kong). For example, we've found 3 warning signs for Lam Soon (Hong Kong) (1 is potentially serious!) that deserve your attention before investing in the shares.

If you're in the market for strong dividend payers, we recommend checking our selection of top dividend stocks.

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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.