Factors Income Investors Should Consider Before Adding Chung Hwa Pulp Corporation (TPE:1905) To Their Portfolio

Dividend paying stocks like Chung Hwa Pulp Corporation (TPE:1905) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a six-year payment history and a 3.5% yield, many investors probably find Chung Hwa Pulp intriguing. It sure looks interesting on these metrics - but there's always more to the story. The company also bought back stock during the year, equivalent to approximately 1.2% of the company's market capitalisation at the time. 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.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. While Chung Hwa Pulp pays a dividend, it reported a loss over the last year. When a company recently reported a loss, we should investigate if its cash flows covered the dividend.

Unfortunately, while Chung Hwa Pulp pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

We update our data on Chung Hwa Pulp 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. Chung Hwa Pulp has been paying a dividend for the past six years. It's good to see that Chung Hwa Pulp 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 six-year period, the first annual payment was NT$0.1 in 2014, compared to NT$0.3 last year. This works out to be a compound annual growth rate (CAGR) of approximately 21% 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.

Chung Hwa Pulp has grown distributions at a rapid rate despite cutting the dividend at least once in the past. Companies that cut once often cut again, but it might be worth considering if the business has turned a corner.

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. Chung Hwa Pulp's EPS have fallen by approximately 43% per year during 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

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. We're a bit uncomfortable with Chung Hwa Pulp paying a dividend while loss-making, especially since the dividend was also not well covered by free cash flow. Earnings per share are down, and Chung Hwa Pulp's dividend has been cut at least once in the past, which is disappointing. Using these criteria, Chung Hwa Pulp looks quite suboptimal from a dividend investment perspective.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. However, there are other things to consider for investors when analysing stock performance. For example, we've identified 3 warning signs for Chung Hwa Pulp (2 are a bit unpleasant!) 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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