Is Chun Zu Machinery Industry Co., Ltd. (GTSM:4544) A Risky Dividend Stock?

Dividend paying stocks like Chun Zu Machinery Industry Co., Ltd. (GTSM:4544) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Chun Zu Machinery Industry is a new dividend aristocrat in the making. It sure looks interesting on these metrics - but there's always more to the story. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

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Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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, Chun Zu Machinery Industry paid out 79% of its profit as dividends. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Chun Zu Machinery Industry paid out 525% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. Chun Zu Machinery Industry paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Chun Zu Machinery Industry to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Consider getting our latest analysis on Chun Zu Machinery Industry's financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. The first recorded dividend for Chun Zu Machinery Industry, in the last decade, was eight years ago. Although it has been paying a dividend for several years now, the dividend has been cut at least once, and we're cautious about the consistency of its dividend across a full economic cycle. During the past eight-year period, the first annual payment was NT$2.0 in 2013, compared to NT$0.8 last year. Dividend payments have fallen sharply, down 63% over that time.

When a company's per-share dividend falls we question if this reflects poorly on either external business conditions, or the company's capital allocation decisions. Either way, we find it hard to get excited about a company with a declining dividend.

Dividend Growth Potential

With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Chun Zu Machinery Industry's earnings per share have shrunk at 16% a year over the past five years. A sharp decline in earnings per share is not great from from a dividend perspective, as even conservative payout ratios can come under pressure if earnings fall far enough.

Conclusion

To summarise, shareholders should always check that Chun Zu Machinery Industry's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Chun Zu Machinery Industry gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. Using these criteria, Chun Zu Machinery Industry looks quite suboptimal from a dividend investment perspective.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. Case in point: We've spotted 5 warning signs for Chun Zu Machinery Industry (of which 1 is a bit concerning!) you should know about.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding 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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