Dividend paying stocks like Herald Holdings Limited (HKG:114) 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, Herald Holdings likely looks attractive to investors, given its 5.3% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. There are a few simple ways to reduce the risks of buying Herald Holdings for its dividend, and we'll go through these below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Herald Holdings paid out 320% of its profit as dividends, over the trailing twelve month period. Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a payout ratio of above 100% is definitely a concern.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Herald Holdings paid out 64% of its free cash flow last year, which is acceptable, but is starting to limit the amount of earnings that can be reinvested into the business. It's disappointing to see that the dividend was not covered by profits, but cash is more important from a dividend sustainability perspective, and Herald Holdings fortunately did generate enough cash to fund its dividend. If executives were to continue paying more in dividends than the company reported in profits, we'd view this as a warning sign. Very few companies are able to sustainably pay dividends larger than their reported earnings.
With a strong net cash balance, Herald Holdings investors may not have much to worry about in the near term from a dividend perspective.
Remember, you can always get a snapshot of Herald Holdings's latest financial position, by checking our visualisation of its financial health.
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. For the purpose of this article, we only scrutinise the last decade of Herald Holdings's dividend payments. The dividend has been cut on at least one occasion historically. During the past ten-year period, the first annual payment was HK$0.08 in 2010, compared to HK$0.04 last year. This works out to be a decline of approximately 6.7% per year over that time. Herald Holdings's dividend hasn't shrunk linearly at 6.7% per annum, but the CAGR is a useful estimate of the historical rate of change.
We struggle to make a case for buying Herald Holdings for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
With a relatively unstable dividend, and a poor history of shrinking dividends, it's even more important to see if EPS are growing. Over the past five years, it looks as though Herald Holdings's EPS have declined at around 19% a 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.
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. We're not keen on the fact that Herald Holdings paid out such a high percentage of its income, although its cashflow is in better shape. Earnings per share have been falling, and the company has cut its dividend at least once in the past. From a dividend perspective, this is a cause for concern. Using these criteria, Herald Holdings looks quite suboptimal from a dividend investment perspective.
See if management have their own wealth at stake, by checking insider shareholdings in Herald Holdings stock.
We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.
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.
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