Dividend paying stocks like Dah Chong Hong Holdings Limited (HKG:1828) 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. Yet sometimes, investors buy a popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
In this case, Dah Chong Hong Holdings likely looks attractive to investors, given its 7.1% dividend yield and a payment history of over ten years. It would not be a surprise to discover that many investors buy it for the dividends. Some simple analysis can offer a lot of insights when buying a company for its dividend, and we'll go through this below.
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. Looking at the data, we can see that 43% of Dah Chong Hong Holdings's profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Plus, there is room to increase the payout ratio over time.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Dah Chong Hong Holdings paid out 20% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's positive to see that Dah Chong Hong Holdings's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Is Dah Chong Hong Holdings's Balance Sheet Risky?
As Dah Chong Hong Holdings has a meaningful amount of debt, we need to check its balance sheet to see if the company might have debt risks. A rough way to check this is with these two simple ratios: a) net debt divided by EBITDA (earnings before interest, tax, depreciation and amortisation), and b) net interest cover. Net debt to EBITDA is a measure of a company's total debt. Net interest cover measures the ability to meet interest payments. Essentially we check that a) the company does not have too much debt, and b) that it can afford to pay the interest. Dah Chong Hong Holdings is carrying net debt of 3.30 times its EBITDA, which is getting towards the upper limit of our comfort range on a dividend stock that the investor hopes will endure a wide range of economic circumstances.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. With EBIT of 3.82 times its interest expense, Dah Chong Hong Holdings's interest cover is starting to look a bit thin.
We update our data on Dah Chong Hong Holdings every 24 hours, so you can always get our latest analysis of its financial health, here.
One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Dah Chong Hong Holdings's dividend payments. Its dividend payments have fallen by 20% or more on at least one occasion over the past ten years. During the past ten-year period, the first annual payment was HK$0.094 in 2009, compared to HK$0.17 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.9% a year over that time. The dividends haven't grown at precisely 5.9% every year, but this is a useful way to average out the historical rate of growth.
It's good to see the dividend growing at a decent rate, but the dividend has been cut at least once in the past. Dah Chong Hong Holdings might have put its house in order since then, but we remain cautious.
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 Dah Chong Hong Holdings's have fallen at approximately 4.5% over the past five years. If earnings continue to decline, the dividend may come under pressure. Every investor should make an assessment of whether the company is taking steps to stabilise the situation.
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. First, we like that the company's dividend payments appear well covered, although the retained capital also needs to be effectively reinvested. Earnings per share are down, and Dah Chong Hong Holdings's dividend has been cut at least once in the past, which is disappointing. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Dah Chong Hong Holdings out there.
Now, if you want to look closer, it would be worth checking out our free research on Dah Chong Hong Holdings management tenure, salary, and performance.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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 firstname.lastname@example.org. 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.