Three Things You Should Check Before Buying Formosan Union Chemical Corp. (TPE:1709) For Its Dividend

Could Formosan Union Chemical Corp. (TPE:1709) 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 your dividends, it's important to be more stringent with your investments than the average punter. Regular readers know we like to apply the same approach to each dividend stock, and we hope you'll find our analysis useful.

In this case, Formosan Union Chemical likely looks attractive to dividend investors, given its 3.3% dividend yield and nine-year payment history. It sure looks interesting on these metrics - but there's always more to the story. The company also returned around 3.5% of its market capitalisation to shareholders in the form of stock buybacks over the past year. There are a few simple ways to reduce the risks of buying Formosan Union Chemical for its dividend, and we'll go through these below.

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%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It's positive to see that Formosan Union Chemical's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.

We update our data on Formosan Union Chemical 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. Looking at the last decade of data, we can see that Formosan Union Chemical paid its first dividend at least nine 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 nine-year period, the first annual payment was NT$0.7 in 2011, compared to NT$0.5 last year. The dividend has shrunk at around 4.2% a year during that period. Formosan Union Chemical's dividend has been cut sharply at least once, so it hasn't fallen by 4.2% every year, but this is a decent approximation of the long term change.

We struggle to make a case for buying Formosan Union Chemical for its dividend, given that payments have shrunk over the past nine years.

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? It's good to see Formosan Union Chemical has been growing its earnings per share at 15% a year over the past five years. Formosan Union Chemical's earnings per share have grown rapidly in recent years, although more than half of its profits are being paid out as dividends, which makes us wonder if the company has a limited number of reinvestment opportunities in its business.

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. Formosan Union Chemical's payout ratios are within a normal range for the average corporation, and we like that its cashflow was stronger than reported profits. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. Overall we think Formosan Union Chemical is an interesting dividend stock, although it could be better.

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 identified 2 warning signs for Formosan Union Chemical (1 is a bit concerning!) 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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