Dividend paying stocks like Nanjing Sample Technology Company Limited (HKG:1708) 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. 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.
A 1.7% yield is nothing to get excited about, but investors probably think the long payment history suggests Nanjing Sample Technology has some staying power. Some simple research can reduce the risk of buying Nanjing Sample Technology for its dividend - read on to learn more.
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. In the last year, Nanjing Sample Technology paid out 40% of its profit as dividends. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Last year, Nanjing Sample Technology paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.
Is Nanjing Sample Technology's Balance Sheet Risky?
As Nanjing Sample Technology 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. With net debt of 2.35 times its EBITDA, Nanjing Sample Technology has a noticeable amount of debt, although if business stays steady, this may not be overly concerning.
Net interest cover can be calculated by dividing earnings before interest and tax (EBIT) by the company's net interest expense. Net interest cover of 5.92 times its interest expense appears reasonable for Nanjing Sample Technology, although we're conscious that even high interest cover doesn't make a company bulletproof.
We update our data on Nanjing Sample Technology 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 Nanjing Sample Technology's dividend payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was CN¥0.08 in 2009, compared to CN¥0.10 last year. Dividends per share have grown at approximately 2.3% per year over this time. The growth in dividends has not been linear, but the CAGR is a decent approximation of the rate of change over this time frame.
Modest growth in the dividend is good to see, but we think this is offset by historical cuts to the payments. It is hard to live on a dividend income if the company's earnings are not consistent.
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. Earnings have grown at around 2.1% a year for the past five years, which is better than seeing them shrink! Nanjing Sample Technology is paying out less than half of its earnings, which we like. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?
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. Nanjing Sample Technology has a low payout ratio, which we like, although it paid out virtually all of its generated cash. 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. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Nanjing Sample Technology out there.
Are management backing themselves to deliver performance? Check their shareholdings in Nanjing Sample Technology 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%.
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