It Might Not Be A Great Idea To Buy Favelle Favco Berhad (KLSE:FAVCO) For Its Next 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 Favelle Favco Berhad (KLSE:FAVCO) is about to go ex-dividend in just three days. The ex-dividend date is two business days before a company's record date in most cases, which is the date on which the company determines which shareholders are entitled 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. Thus, you can purchase Favelle Favco Berhad's shares before the 31st of July in order to receive the dividend, which the company will pay on the 15th of August.

The company's next dividend payment will be RM00.09 per share, on the back of last year when the company paid a total of RM0.09 to shareholders. Based on the last year's worth of payments, Favelle Favco Berhad stock has a trailing yield of around 5.1% on the current share price of RM01.77. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to investigate whether Favelle Favco Berhad can afford its dividend, and if the dividend could grow.

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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. Fortunately Favelle Favco Berhad's payout ratio is modest, at just 39% of profit. 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. Over the last year, it paid out dividends equivalent to 321% of what it generated in free cash flow, a disturbingly high percentage. Unless there were something in the business we're not grasping, this could signal a risk that the dividend may have to be cut in the future.

Favelle Favco Berhad does have a large net cash position on the balance sheet, which could fund large dividends for a time, if the company so chose. Still, smart investors know that it is better to assess dividends relative to the cash and profit generated by the business. Paying dividends out of cash on the balance sheet is not long-term sustainable.

While Favelle Favco Berhad'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. Were this to happen repeatedly, this would be a risk to Favelle Favco Berhad's ability to maintain its dividend.

View our latest analysis for Favelle Favco Berhad

Click here to see how much of its profit Favelle Favco Berhad 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 business enters a downturn and the dividend is cut, the company could see its value fall precipitously. Readers will understand then, why we're concerned to see Favelle Favco Berhad's earnings per share have dropped 9.2% a year over the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Favelle Favco Berhad has seen its dividend decline 2.8% per annum on average over the past 10 years, which is not great to see. While it's not great that earnings and dividends per share have fallen in recent years, we're encouraged by the fact that management has trimmed the dividend rather than risk over-committing the company in a risky attempt to maintain yields to shareholders.

The Bottom Line

From a dividend perspective, should investors buy or avoid Favelle Favco Berhad? It's disappointing to see earnings per share declining, and this would ordinarily be enough to discourage us from most dividend stocks, even though Favelle Favco Berhad is paying out less than half its income as dividends. However, it's also paying out an uncomfortably high percentage of its cash flow, which makes us wonder just how sustainable the dividend really is. Bottom line: Favelle Favco Berhad has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

Although, if you're still interested in Favelle Favco Berhad and want to know more, you'll find it very useful to know what risks this stock faces. Be aware that Favelle Favco Berhad is showing 3 warning signs in our investment analysis, and 1 of those is significant...

Generally, we wouldn't recommend just buying the first dividend stock you see. Here's a curated list of interesting stocks that are strong dividend payers.

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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.