Investors In Formosa Plastics Corporation (TPE:1301) Should Consider This, First

Could Formosa Plastics Corporation (TPE:1301) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

In this case, Formosa Plastics likely looks attractive to investors, given its 4.0% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. There are a few simple ways to reduce the risks of buying Formosa Plastics for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Formosa Plastics!

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 140% of Formosa Plastics' profits were paid out as dividends in the last 12 months. 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.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Formosa Plastics paid out 125% of its free cash flow last year, which we think is concerning if cash flows do not improve. Cash is slightly more important than profit from a dividend perspective, but given Formosa Plastics' payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

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

Remember, you can always get a snapshot of Formosa Plastics' latest financial position, by checking our visualisation of its financial health.

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. Formosa Plastics has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of 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$4.4 last year. This works out to be a compound annual growth rate (CAGR) of approximately 1.4% a year over that time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.

It's good to see some dividend growth, but the dividend has been cut at least once, and the size of the cut would eliminate most of the growth, anyway. We're not that enthused by this.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? In the last five years, Formosa Plastics' earnings per share have shrunk at approximately 8.3% per annum. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. It's a concern to see that the company paid out such a high percentage of its earnings and cashflow as dividends. Earnings per share are down, and Formosa Plastics' dividend has been cut at least once in the past, which is disappointing. Using these criteria, Formosa Plastics looks quite suboptimal from a dividend investment perspective.

Market movements attest to how highly valued a consistent dividend policy is compared to one which is more unpredictable. However, there are other things to consider for investors when analysing stock performance. For example, we've picked out 2 warning signs for Formosa Plastics that investors should know about before committing capital to this stock.

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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