Why It Might Not Make Sense To Buy Hwacheon Machine Tool Co. Ltd (KRX:000850) For Its Upcoming Dividend

Some investors rely on dividends for growing their wealth, and if you're one of those dividend sleuths, you might be intrigued to know that Hwacheon Machine Tool Co. Ltd (KRX:000850) is about to go ex-dividend in just four days. If you purchase the stock on or after the 29th of December, you won't be eligible to receive this dividend, when it is paid on the 17th of April.

Hwacheon Machine Tool's upcoming dividend is ₩1,250 a share, following on from the last 12 months, when the company distributed a total of ₩1,250 per share to shareholders. Looking at the last 12 months of distributions, Hwacheon Machine Tool has a trailing yield of approximately 3.8% on its current stock price of ₩32900. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. As a result, readers should always check whether Hwacheon Machine Tool has been able to grow its dividends, or if the dividend might be cut.

See our latest analysis for Hwacheon Machine Tool

Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. Hwacheon Machine Tool paid out 111% 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 Hwacheon Machine Tool generated enough free cash flow to afford its dividend. Thankfully its dividend payments took up just 27% of the free cash flow it generated, which is a comfortable payout ratio.

It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Hwacheon Machine Tool fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.

Click here to see how much of its profit Hwacheon Machine Tool paid out over the last 12 months.

Have Earnings And Dividends Been Growing?

Businesses with shrinking earnings are tricky from a dividend perspective. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Hwacheon Machine Tool's earnings per share have plummeted approximately 35% a year over the previous five years.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Hwacheon Machine Tool has delivered an average of 3.8% per year annual increase in its dividend, based on the past 10 years of dividend payments. 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. Hwacheon Machine Tool is already paying out 111% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

From a dividend perspective, should investors buy or avoid Hwacheon Machine Tool? It's not a great combination to see a company with earnings in decline and paying out 111% of its profits, which could imply the dividend may be at risk of being cut in the future. Yet cashflow was much stronger, which makes us wonder if there are some large timing issues in Hwacheon Machine Tool's cash flows, or perhaps the company has written down some assets aggressively, reducing its income. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Although, if you're still interested in Hwacheon Machine Tool and want to know more, you'll find it very useful to know what risks this stock faces. Every company has risks, and we've spotted 4 warning signs for Hwacheon Machine Tool (of which 1 doesn't sit too well with us!) you should know about.

We wouldn't recommend just buying the first dividend stock you see, though. Here's a list of interesting dividend stocks with a greater than 2% yield and an upcoming dividend.

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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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