Here's Why We're Wary Of Buying Formosa Chemicals & Fibre's (TWSE:1326) For Its Upcoming Dividend

Regular readers will know that we love our dividends at Simply Wall St, which is why it's exciting to see Formosa Chemicals & Fibre Corporation (TWSE:1326) is about to trade ex-dividend in the next 4 days. The ex-dividend date occurs one day before the record date which is the day on which shareholders need to be on the company's books in order to receive a dividend. The ex-dividend date is important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. Therefore, if you purchase Formosa Chemicals & Fibre's shares on or after the 10th of July, you won't be eligible to receive the dividend, when it is paid on the 9th of August.

The company's next dividend payment will be NT$1.25 per share, on the back of last year when the company paid a total of NT$1.25 to shareholders. Looking at the last 12 months of distributions, Formosa Chemicals & Fibre has a trailing yield of approximately 2.5% on its current stock price of NT$49.40. We love seeing companies pay a dividend, but it's also important to be sure that laying the golden eggs isn't going to kill our golden goose! We need to see whether the dividend is covered by earnings and if it's growing.

Check out our latest analysis for Formosa Chemicals & Fibre

Dividends are typically paid out of company income, so if a company pays out more than it earned, its dividend is usually at a higher risk of being cut. Formosa Chemicals & Fibre paid out more than half (67%) of its earnings last year, which is a regular payout ratio for most companies. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. Formosa Chemicals & Fibre paid out more free cash flow than it generated - 161%, to be precise - last year, which we think is concerningly high. It's hard to consistently pay out more cash than you generate without either borrowing or using company cash, so we'd wonder how the company justifies this payout level.

While Formosa Chemicals & Fibre's dividends were covered by the company's reported profits, cash is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were this to happen repeatedly, this would be a risk to Formosa Chemicals & Fibre's ability to maintain its dividend.

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. Formosa Chemicals & Fibre's earnings per share have fallen at approximately 26% a year over the previous five years. Such a sharp decline casts doubt on the future sustainability of the dividend.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Formosa Chemicals & Fibre has delivered an average of 7.1% per year annual increase in its dividend, based on the past 10 years of dividend payments. That's interesting, but the combination of a growing dividend despite declining earnings can typically only be achieved by paying out more of the company's profits. This can be valuable for shareholders, but it can't go on forever.

The Bottom Line

Is Formosa Chemicals & Fibre an attractive dividend stock, or better left on the shelf? Formosa Chemicals & Fibre had an average payout ratio, but its free cash flow was lower and earnings per share have been declining. It's not that we think Formosa Chemicals & Fibre is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with Formosa Chemicals & Fibre. Our analysis shows 1 warning sign for Formosa Chemicals & Fibre and you should be aware of this before buying any shares.

If you're in the market for strong dividend payers, we recommend checking our selection of top dividend stocks.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com