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Do Investors Have Good Reason To Be Wary Of Tomson Group Limited's (HKG:258) 7.7% Dividend Yield?

Simply Wall St

Is Tomson Group Limited (HKG:258) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. Yet sometimes, investors buy a stock for its dividend and lose money because the share price falls by more than they earned in dividend payments.

In this case, Tomson Group likely looks attractive to investors, given its 7.7% dividend yield and a payment history of over ten years. We'd guess that plenty of investors have purchased it for the income. Before you buy any stock for its dividend however, you should always remember Warren Buffett's two rules: 1) Don't lose money, and 2) Remember rule #1. We'll run through some checks below to help with this.

Click the interactive chart for our full dividend analysis

SEHK:258 Historical Dividend Yield, July 22nd 2019

Payout ratios

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned, 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 88% of Tomson Group's profits were paid out as dividends in the last 12 months. Paying out a majority of its earnings limits the amount that can be reinvested in the business. This may indicate a commitment to paying a dividend, or a dearth of investment opportunities.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Last year, Tomson Group paid a dividend while reporting negative free cash flow. While there may be an explanation, we think this behaviour is generally not sustainable.

While the above analysis focuses on dividends relative to a company's earnings, we do note Tomson Group's strong net cash position, which will let it pay larger dividends for a time, should it choose.

Consider getting our latest analysis on Tomson Group's financial position 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. For the purpose of this article, we only scrutinise the last decade of Tomson Group'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 HK$0.055 in 2009, compared to HK$0.18 last year. Dividends per share have grown at approximately 13% per year over this time. Tomson Group's dividend payments have fluctuated, so it hasn't grown 13% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.

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? Tomson Group's earnings per share have been essentially flat over the past five years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation.

Conclusion

To summarise, shareholders should always check that Tomson Group's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Tomson Group gets a pass on its dividend payout ratio, but it paid out virtually all of its cash flow as dividends. This may just be a one-off, but we'd keep an eye on this. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. There are a few too many issues for us to get comfortable with Tomson Group from a dividend perspective. Businesses can change, but we would struggle to identify why an investor should rely on this stock for their income.

Are management backing themselves to deliver performance? Check their shareholdings in Tomson Group in our latest insider ownership analysis.

Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield 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.