Gallant Micro. Machining Co., LTD. (GTSM:6640) Investors Should Think About This Before Buying It For Its Dividend

Dividend paying stocks like Gallant Micro. Machining Co., LTD. (GTSM:6640) 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. 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.

Gallant Micro. Machining pays a 4.4% dividend yield, and has been paying dividends for the past three years. It's certainly an attractive yield, but readers are likely curious about its staying power. Remember though, due to the recent spike in its share price, Gallant Micro. Machining's yield will look lower, even though the market may now be factoring in an improvement in its long-term prospects. 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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Gallant Micro. Machining paid out 156% of its profit as dividends, over the trailing twelve month period. 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. Last year, Gallant Micro. Machining paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

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

Consider getting our latest analysis on Gallant Micro. Machining's financial position here.

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. The company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. Its most recent annual dividend was NT$3.0 per share, effectively flat on its first payment three years ago.

It's good to see at least some dividend growth. Yet with a relatively short dividend paying history, we wouldn't want to depend on this dividend too heavily.

Dividend Growth Potential

While dividend payments have been relatively reliable, it would also be nice if earnings per share (EPS) were growing, as this is essential to maintaining the dividend's purchasing power over the long term. Gallant Micro. Machining's EPS have fallen by approximately 17% 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.

We'd also point out that Gallant Micro. Machining issued a meaningful number of new shares in the past year. Regularly issuing new shares can be detrimental - it's hard to grow dividends per share when new shares are regularly being created.

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 Gallant Micro. Machining paying out a high percentage of both its cashflow and earnings. Earnings per share are down, and to our mind Gallant Micro. Machining has not been paying a dividend long enough to demonstrate its resilience across economic cycles. Using these criteria, Gallant Micro. Machining looks quite suboptimal from a dividend investment perspective.

It's important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Meanwhile, despite the importance of dividend payments, they are not the only factors our readers should know when assessing a company. Just as an example, we've come accross 6 warning signs for Gallant Micro. Machining you should be aware of, and 2 of them can't be ignored.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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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