Does It Make Sense To Buy China Steel Chemical Corporation (TPE:1723) For Its Yield?

Dividend paying stocks like China Steel Chemical Corporation (TPE:1723) 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. 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.

In this case, China Steel Chemical likely looks attractive to investors, given its 5.0% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

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. 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, China Steel Chemical paid out 176% of its profit as dividends. A payout ratio above 100% is definitely an item of concern, unless there are some other circumstances that would justify it.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. With a cash payout ratio of 130%, China Steel Chemical's dividend payments are poorly covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. Cash is slightly more important than profit from a dividend perspective, but given China Steel Chemical's payouts were not well covered by either earnings or cash flow, we would definitely be concerned about the sustainability of this dividend.

Consider getting our latest analysis on China Steel Chemical'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. China Steel Chemical has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut on at least one occasion historically. During the past 10-year period, the first annual payment was NT$5.6 in 2011, compared to NT$5.0 last year. This works out to be a decline of approximately 1.1% per year over that time. China Steel Chemical's dividend hasn't shrunk linearly at 1.1% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying China Steel Chemical 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 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? China Steel Chemical's earnings per share have shrunk at 14% 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 China Steel Chemical's earnings per share, which support the dividend, have been anything but stable.

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. We're a bit uncomfortable with China Steel Chemical 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 China Steel Chemical from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. Taking the debate a bit further, we've identified 3 warning signs for China Steel Chemical that investors need to be conscious of moving forward.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

If you’re looking to trade China Steel Chemical, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade 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.