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Would Union Medical Healthcare Limited (HKG:2138) Be Valuable To Income Investors?

Simply Wall St

Dividend paying stocks like Union Medical Healthcare Limited (HKG:2138) 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. On the other hand, investors have been known to buy a stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.

With a four-year payment history and a 6.9% yield, many investors probably find Union Medical Healthcare intriguing. It sure looks interesting on these metrics - but there's always more to the story . 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:2138 Historical Dividend Yield, February 3rd 2020

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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. Looking at the data, we can see that 58% of Union Medical Healthcare's profits were paid out as dividends in the last 12 months. A payout ratio above 50% generally implies a business is reaching maturity, although it is still possible to reinvest in the business or increase the dividend over time.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. Union Medical Healthcare paid out 247% of its free cash last year. Cash flows can be lumpy, but this dividend was not well covered by cash flow. Paying out more than 100% of your free cash flow in dividends is generally not a long-term, sustainable state of affairs, so we think shareholders should watch this metric closely. While Union Medical Healthcare's dividends were covered by the company's reported profits, free cash flow is somewhat more important, so it's not great to see that the company didn't generate enough cash to pay its dividend. Were it to repeatedly pay dividends that were not well covered by cash flow, this could be a risk to Union Medical Healthcare's ability to maintain its dividend.

With a strong net cash balance, Union Medical Healthcare investors may not have much to worry about in the near term from a dividend perspective.

Consider getting our latest analysis on Union Medical Healthcare'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. Union Medical Healthcare has been paying a dividend for the past four years. 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 four-year period, the first annual payment was HK$0.019 in 2016, compared to HK$0.35 last year. This works out to be a compound annual growth rate (CAGR) of approximately 107% 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

Dividend payments have been consistent over the past few years, but we should always check if earnings per share (EPS) are growing, as this will help maintain the purchasing power of the dividend. It's good to see Union Medical Healthcare has been growing its earnings per share at 27% a year over the past five years. With recent, rapid earnings per share growth and a payout ratio of 58%, this business looks like an interesting prospect if earnings are reinvested effectively.

Conclusion

To summarise, shareholders should always check that Union Medical Healthcare's dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. First, we think Union Medical Healthcare has an acceptable payout ratio, although its dividend was not well covered by cashflow. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Union Medical Healthcare out there.

Companies that are growing earnings tend to be the best dividend stocks over the long term. See what the 3 analysts we track are forecasting for Union Medical Healthcare for free with public analyst estimates for the company.

If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.

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.

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. Thank you for reading.