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Dongguang Chemical Limited (HKG:1702) Is Yielding 2.2% - But Is It A Buy?

Simply Wall St

Could Dongguang Chemical Limited (HKG:1702) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the 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.

Some readers mightn't know much about Dongguang Chemical's 2.2% dividend, as it has only been paying distributions for a year or so. 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 Dongguang Chemical!

SEHK:1702 Historical Dividend Yield, November 13th 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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Dongguang Chemical paid out 15% of its profit as dividends, over the trailing twelve month period. With a low payout ratio, it looks like the dividend is comprehensively covered by earnings.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Dongguang Chemical paid out 5.7% of its free cash flow as dividends last year, which is conservative and suggests the dividend is sustainable. It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

We update our data on Dongguang Chemical every 24 hours, so you can always get our latest analysis of its financial health, here.

Dividend Volatility

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. This company has been paying a dividend for less than 2 years, which we think is too soon to consider it a reliable dividend stock. This works out to be a compound annual growth rate (CAGR) of approximately 111% a year over that time.

The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.

Dividend Growth Potential

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Dongguang Chemical has grown its earnings per share at 3.6% per annum over the past five years. So, we know earnings growth has been thin on the ground. On the plus side, the dividend payout ratio is low and dividends could grow faster than earnings, if the company decides to increase its payout ratio.

We'd also point out that Dongguang Chemical 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. It's great to see that Dongguang Chemical is paying out a low percentage of its earnings and cash flow. Second, earnings growth has been ordinary, and its history of dividend payments is shorter than we'd like. Overall we think Dongguang Chemical is an interesting dividend stock, although it could be better.

Now, if you want to look closer, it would be worth checking out our free research on Dongguang Chemical 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 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.