Why It Might Not Make Sense To Buy The Hong Kong and China Gas Company Limited (HKG:3) For Its Upcoming Dividend

It looks like The Hong Kong and China Gas Company Limited (HKG:3) is about to go ex-dividend in the next three days. The ex-dividend date generally occurs two days before the record date, which is the day on which shareholders need to be on the company's books in order to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade can take two business days or more to settle. Accordingly, Hong Kong and China Gas investors that purchase the stock on or after the 6th of June will not receive the dividend, which will be paid on the 23rd of June.

The company's next dividend payment will be HK$0.23 per share, on the back of last year when the company paid a total of HK$0.35 to shareholders. Based on the last year's worth of payments, Hong Kong and China Gas stock has a trailing yield of around 5.1% on the current share price of HK$6.90. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

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Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. Hong Kong and China Gas paid out 114% of profit in the past year, which we think is typically not sustainable unless there are mitigating characteristics such as unusually strong cash flow or a large cash balance. A useful secondary check can be to evaluate whether Hong Kong and China Gas generated enough free cash flow to afford its dividend. It paid out an unsustainably high 255% of its free cash flow as dividends over the past 12 months, which is worrying. Our definition of free cash flow excludes cash generated from asset sales, so since Hong Kong and China Gas is paying out such a high percentage of its cash flow, it might be worth seeing if it sold assets or had similar events that might have led to such a high dividend payment.

As Hong Kong and China Gas's dividend was not well covered by either earnings or cash flow, we would be concerned that this dividend could be at risk over the long term.

Check out our latest analysis for Hong Kong and China Gas

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. That's why it's not ideal to see Hong Kong and China Gas's earnings per share have been shrinking at 3.9% a year over the previous five years.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Since the start of our data, 10 years ago, Hong Kong and China Gas has lifted its dividend by approximately 6.9% a year on average. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Hong Kong and China Gas is already paying out 114% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

To Sum It Up

Should investors buy Hong Kong and China Gas for the upcoming dividend? Not only are earnings per share declining, but Hong Kong and China Gas is paying out an uncomfortably high percentage of both its earnings and cashflow to shareholders as dividends. This is a clearly suboptimal combination that usually suggests the dividend is at risk of being cut. If not now, then perhaps in the future. It's not the most attractive proposition from a dividend perspective, and we'd probably give this one a miss for now.

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 Hong Kong and China Gas. Our analysis shows 2 warning signs for Hong Kong and China Gas and you should be aware of them before buying any 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.