Read This Before Buying Formosan Union Chemical Corp. (TPE:1709) For Its Dividend

Today we'll take a closer look at Formosan Union Chemical Corp. (TPE:1709) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

With a nine-year payment history and a 3.4% yield, many investors probably find Formosan Union Chemical intriguing. We'd agree the yield does look enticing. The company also bought back stock during the year, equivalent to approximately 3.5% of the company's market capitalisation at the time. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Formosan Union Chemical!

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Formosan Union Chemical paid out 56% of its profit as dividends. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Formosan Union Chemical'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 encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

Remember, you can always get a snapshot of Formosan Union Chemical's latest financial position, by checking our visualisation of its financial health.

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. Looking at the last decade of data, we can see that Formosan Union Chemical paid its first dividend at least nine years ago. It's good to see that Formosan Union Chemical has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past nine-year period, the first annual payment was NT$0.7 in 2012, compared to NT$0.5 last year. This works out to be a decline of approximately 4.2% per year over that time. Formosan Union Chemical's dividend hasn't shrunk linearly at 4.2% per annum, but the CAGR is a useful estimate of the historical rate of change.

A shrinking dividend over a nine-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. In the last five years, Formosan Union Chemical's earnings per share have shrunk at approximately 7.7% per annum. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.

Conclusion

When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we think Formosan Union Chemical has an acceptable payout ratio and its dividend is well covered by cashflow. Earnings per share are down, and Formosan Union Chemical's dividend has been cut at least once in the past, which is disappointing. In sum, we find it hard to get excited about Formosan Union Chemical from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For example, we've identified 2 warning signs for Formosan Union Chemical (1 makes us a bit uncomfortable!) that you should be aware of before investing.

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