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Should You Buy Chongqing Machinery & Electric Co., Ltd. (HKG:2722) For Its 7.1% Dividend?

Simply Wall St

Today we'll take a closer look at Chongqing Machinery & Electric Co., Ltd. (HKG:2722) 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. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

With a goodly-sized dividend yield despite a relatively short payment history, investors might be wondering if Chongqing Machinery & Electric is a new dividend aristocrat in the making. We'd agree the yield does look enticing. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Chongqing Machinery & Electric!

SEHK:2722 Historical Dividend Yield, July 29th 2019

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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Chongqing Machinery & Electric paid out 33% of its profit as dividends, over the trailing twelve month period. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, Chongqing Machinery & Electric paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

Remember, you can always get a snapshot of Chongqing Machinery & Electric's latest financial position, by checking our visualisation of its financial health.

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. Looking at the last decade of data, we can see that Chongqing Machinery & Electric paid its first dividend at least nine years ago. It's good to see that Chongqing Machinery & Electric 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 nine-year period, the first annual payment was CN¥0.06 in 2010, compared to CN¥0.04 last year. The dividend has shrunk at around 4.4% a year during that period. Chongqing Machinery & Electric's dividend has been cut sharply at least once, so it hasn't fallen by 4.4% every year, but this is a decent approximation of the long term change.

When a company's per-share dividend falls we question if this reflects poorly on either the business or management. Either way, we find it hard to get excited about a company with a declining dividend.

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. It's not great to see that Chongqing Machinery & Electric's have fallen at approximately 2.7% over the past five years. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.

Conclusion

To summarise, shareholders should always check that Chongqing Machinery & Electric's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Chongqing Machinery & Electric has a low payout ratio, which we like, although it paid out virtually all of its generated cash. Unfortunately, the company has not been able to generate earnings per share growth, and cut its dividend at least once in the past. With this information in mind, we think Chongqing Machinery & Electric may not be an ideal dividend stock.

Now, if you want to look closer, it would be worth checking out our free research on Chongqing Machinery & Electric management tenure, salary, and performance.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.