Today we'll take a closer look at Jacobson Pharma Corporation Limited (HKG:2633) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. 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.
Jacobson Pharma yields a solid 3.1%, although it has only been paying for three years. A high yield probably looks enticing, but investors are likely wondering about the short payment history. There are a few simple ways to reduce the risks of buying Jacobson Pharma for its dividend, and we'll go through these below.
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. 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, Jacobson Pharma paid out 35% of its profit as dividends. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. Plus, there is room to increase the payout ratio over time.
Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Jacobson Pharma paid out a conservative 25% of its free cash flow as dividends last year. It's positive to see that Jacobson Pharma's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
Consider getting our latest analysis on Jacobson Pharma's financial position here.
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. The dividend has not fluctuated much, but with a relatively short payment history, we can't be sure this is sustainable across a full market cycle. During the past three-year period, the first annual payment was HK$0.016 in 2016, compared to HK$0.045 last year. This works out to be a compound annual growth rate (CAGR) of approximately 41% a year over that time.
We're not overly excited about the relatively short history of dividend payments, however the dividend is growing at a nice rate and we might take a closer look.
Dividend Growth Potential
The other half of the dividend investing equation is evaluating whether earnings per share (EPS) are growing. Over the long term, dividends need to grow at or above the rate of inflation, in order to maintain the recipient's purchasing power. Jacobson Pharma's EPS are effectively 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.
We'd also point out that Jacobson Pharma issued a meaningful number of new shares in the past year. Trying to grow the dividend when issuing new shares reminds us of the ancient Greek tale of Sisyphus - perpetually pushing a boulder uphill. Companies that consistently issue new shares are often suboptimal from a dividend perspective.
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. Firstly, we like that Jacobson Pharma has low and conservative payout ratios. Second, the company has not been able to generate earnings growth, and its history of dividend payments too short for us to thoroughly evaluate the dividend's consistency across an economic cycle. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Jacobson Pharma out there.
Now, if you want to look closer, it would be worth checking out our free research on Jacobson Pharma management tenure, salary, and performance.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
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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. Thank you for reading.