Does Formosa Petrochemical Corporation (TPE:6505) Have A Place In Your Dividend Stock Portfolio?

Is Formosa Petrochemical Corporation (TPE:6505) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

While Formosa Petrochemical's 2.9% dividend yield is not the highest, we think its lengthy payment history is quite interesting. 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.

Click the interactive chart for our full dividend analysis

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Formosa Petrochemical paid out 642% of its profit as dividends, over the trailing twelve month period. 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. Formosa Petrochemical paid out 104% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. As Formosa Petrochemical'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.

While the above analysis focuses on dividends relative to a company's earnings, we do note Formosa Petrochemical's strong net cash position, which will let it pay larger dividends for a time, should it choose.

We update our data on Formosa Petrochemical every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Formosa Petrochemical's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was NT$3.8 in 2011, compared to NT$2.9 last year. This works out to be a decline of approximately 2.7% per year over that time. Formosa Petrochemical's dividend has been cut sharply at least once, so it hasn't fallen by 2.7% every year, but this is a decent approximation of the long term change.

We struggle to make a case for buying Formosa Petrochemical for its dividend, given that payments have shrunk over the past 10 years.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Formosa Petrochemical's earnings per share have shrunk at 28% 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 Formosa Petrochemical'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 a bit uncomfortable with Formosa Petrochemical paying out a high percentage of both its cashflow and earnings. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. There are a few too many issues for us to get comfortable with Formosa Petrochemical from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Companies possessing a stable dividend policy will likely enjoy greater investor interest than those suffering from a more inconsistent approach. However, there are other things to consider for investors when analysing stock performance. For instance, we've picked out 2 warning signs for Formosa Petrochemical that investors should take into consideration.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

When trading Formosa Petrochemical or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.