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Are Dividend Investors Making A Mistake With CNQC International Holdings Limited (HKG:1240)?

Simply Wall St

Is CNQC International Holdings Limited (HKG:1240) 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.

CNQC International Holdings pays a 8.6% dividend yield, and has been paying dividends for the past three years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. The company also bought back stock equivalent to around 2.7% of market capitalisation this year. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

SEHK:1240 Historical Dividend Yield, September 9th 2019

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. 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. In the last year, CNQC International Holdings paid out 94% of its profit as dividends. With a payout ratio this high, we'd say its dividend is not well covered by earnings. This may be fine if earnings are growing, but it might not take much of a downturn for the dividend to come under pressure.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. CNQC International Holdings paid out 895% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. Cash is slightly more important than profit from a dividend perspective, but given CNQC International Holdings's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

Consider getting our latest analysis on CNQC International Holdings'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. It has only been paying dividends for a few short years, and the dividend has already been cut at least once. This is one income stream we're not ready to live on. During the past three-year period, the first annual payment was HK$0.12 in 2016, compared to HK$0.11 last year. The dividend has shrunk at around 2.9% a year during that period. CNQC International Holdings's dividend hasn't shrunk linearly at 2.9% per annum, but the CAGR is a useful estimate of the historical rate of change.

We struggle to make a case for buying CNQC International Holdings for its dividend, given that payments have shrunk over the past three years.

Dividend Growth Potential

With a relatively unstable dividend, it's even more important to see if earnings per share (EPS) are growing. Why take the risk of a dividend getting cut, unless there's a good chance of bigger dividends in future? CNQC International Holdings's EPS have fallen by approximately 37% per year. 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.

Conclusion

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. CNQC International Holdings paid out almost all of its cash flow and profit as dividends, leaving little to reinvest in the business. Second, earnings per share have been essentially flat, and its history of dividend payments is chequered - having cut its dividend at least once in the past. Using these criteria, CNQC International Holdings looks quite suboptimal from a dividend investment perspective.

Are management backing themselves to deliver performance? Check their shareholdings in CNQC International Holdings in our latest insider ownership analysis.

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.