How Does Lee & Man Chemical Company Limited (HKG:746) Fare As A Dividend Stock?

Dividend paying stocks like Lee & Man Chemical Company Limited (HKG:746) 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, Lee & Man Chemical likely looks attractive to investors, given its 9.6% 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. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

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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. In the last year, Lee & Man Chemical paid out 41% of its profit as dividends. 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 129%, Lee & Man Chemical's dividend payments are poorly covered by cash flow. Lee & Man Chemical paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Lee & Man Chemical's ability to maintain its dividend.

Remember, you can always get a snapshot of Lee & Man Chemical's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

From the perspective of an income investor who wants to earn dividends for many years, there is not much point buying a stock if its dividend is regularly cut or is not reliable. For the purpose of this article, we only scrutinise the last decade of Lee & Man Chemical'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 HK$0.1 in 2011, compared to HK$0.3 last year. This works out to be a compound annual growth rate (CAGR) of approximately 13% a year over that time. Lee & Man Chemical's dividend payments have fluctuated, so it hasn't grown 13% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

Lee & Man Chemical 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? Earnings have grown at around 5.9% a year for the past five years, which is better than seeing them shrink! Earnings per share have been growing at a credible rate. What's more, the payout ratio is reasonable and provides some protection to the dividend, or even the potential to increase it.

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. First, we like Lee & Man Chemical's low dividend payout ratio, although we're a bit concerned that it paid out a substantially higher percentage of its free cash flow. Unfortunately, earnings growth has also been mediocre, and the company has cut its dividend at least once in the past. In sum, we find it hard to get excited about Lee & Man Chemical from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we've picked out 2 warning signs for Lee & Man Chemical 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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