Would PharmaEngine, Inc. (GTSM:4162) Be Valuable To Income Investors?

Is PharmaEngine, Inc. (GTSM:4162) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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 six-year payment history and a 3.4% yield, many investors probably find PharmaEngine intriguing. It sure looks interesting on these metrics - but there's always more to the story. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.

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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. PharmaEngine paid out 60% of its profit as dividends, over the trailing twelve month period. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. PharmaEngine paid out 114% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. PharmaEngine paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to PharmaEngine's ability to maintain its dividend.

With a strong net cash balance, PharmaEngine investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on PharmaEngine'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. PharmaEngine has been paying a dividend for the past six years. 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 six-year period, the first annual payment was NT$0.7 in 2015, compared to NT$2.5 last year. Dividends per share have grown at approximately 24% per year over this time. PharmaEngine's dividend payments have fluctuated, so it hasn't grown 24% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to evaluate if earnings per share (EPS) are growing - it's not worth taking the risk on a dividend getting cut, unless you might be rewarded with larger dividends in future. Earnings have grown at around 9.1% a year for the past five years, which is better than seeing them shrink! The rate at which earnings have grown is quite decent, and by paying out more than half of its earnings as dividends, the company is striking a reasonable balance between reinvestment and returns to shareholders.

Conclusion

To summarise, shareholders should always check that PharmaEngine's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think PharmaEngine has an acceptable payout ratio, although its dividend was not well covered by cashflow. Next, earnings growth has been good, but unfortunately the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than PharmaEngine out there.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. To that end, PharmaEngine has 4 warning signs (and 2 which can't be ignored) we think you should know about.

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