Should You Buy GEM Services, Inc. (TPE:6525) For Its Dividend?

Today we'll take a closer look at GEM Services, Inc. (TPE:6525) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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 five-year payment history and a 5.6% yield, many investors probably find GEM Services intriguing. It sure looks interesting on these metrics - but there's always more to the story. 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.

Explore this interactive chart for our latest analysis on GEM Services!

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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, GEM Services paid out 85% of its profit as dividends. It's paying out most of its earnings, which limits the amount that can be reinvested in the business. This may indicate limited need for further capital within the business, or highlight a commitment to paying a dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. GEM Services paid out 107% of its free cash flow last year, which we think is concerning if cash flows do not improve. GEM Services 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 GEM Services' ability to maintain its dividend.

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

Consider getting our latest analysis on GEM Services' 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. GEM Services has been paying a dividend for the past five years. During the past five-year period, the first annual payment was NT$2.7 in 2016, compared to NT$4.5 last year. This works out to be a compound annual growth rate (CAGR) of approximately 11% 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.

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. GEM Services' EPS are effectively flat over the past five years. Flat earnings per share are acceptable for a time, but over the long term, the purchasing power of the company's dividends could be eroded by inflation. GEM Services' earnings per share have barely grown, which is not ideal - perhaps this is why the company pays out the majority of its earnings to shareholders. That's fine as far as it goes, but we're less enthusiastic as this often signals that the dividend is likely to grow slower in the future.

Conclusion

To summarise, shareholders should always check that GEM Services' dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. GEM Services gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. In summary, GEM Services has a number of shortcomings that we'd find it hard to get past. Things could change, but we think there are likely more attractive alternatives 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. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we've picked out 1 warning sign for GEM Services that investors should take into consideration.

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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