Factors Income Investors Should Consider Before Adding First Hotel Company Ltd. (TPE:2706) To Their Portfolio

Dividend paying stocks like First Hotel Company Ltd. (TPE:2706) 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.

A high yield and a long history of paying dividends is an appealing combination for First Hotel. It would not be a surprise to discover that many investors buy it for the dividends. 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.

Explore this interactive chart for our latest analysis on First Hotel!

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, First Hotel paid out 136% of its profit as dividends. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. First Hotel's cash payout ratio last year was 24%, which is quite low and suggests that the dividend was thoroughly covered by cash flow. It's good to see that while First Hotel's dividends were not covered by profits, at least they are affordable from a cash perspective. Still, if the company repeatedly paid a dividend greater than its profits, we'd be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

With a strong net cash balance, First Hotel investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on First Hotel's financial position here.

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 First Hotel's dividend payments. During this period the dividend has been stable, which could imply the business could have relatively consistent earnings power. During the past 10-year period, the first annual payment was NT$0.07 in 2011, compared to NT$0.5 last year. This works out to be a compound annual growth rate (CAGR) of approximately 21% a year over that time.

Dividends have been growing pretty quickly, and even more impressively, they haven't experienced any notable falls during this period.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. First Hotel's earnings per share have shrunk at 19% a year over the past five years. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and First Hotel's earnings per share, which support the dividend, have been anything but stable.

Conclusion

To summarise, shareholders should always check that First Hotel's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. We're not keen on the fact that First Hotel paid out such a high percentage of its income, although its cashflow is in better shape. It's not great to see earnings per share shrinking. The dividends have been relatively consistent, but we wonder for how much longer this will be true. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than First Hotel out there.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. To that end, First Hotel has 3 warning signs (and 1 which is significant) we think you should know about.

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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