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Why Speed Apparel Holding Limited (HKG:3860) Should Be In Your Dividend Portfolio

Simply Wall St

Is Speed Apparel Holding Limited (HKG:3860) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

Some readers mightn't know much about Speed Apparel Holding's 2.9% dividend, as it has only been paying distributions for the last two years. Many of the best dividend stocks typically start out paying a low yield, so we wouldn't automatically cut it from our list of prospects. There are a few simple ways to reduce the risks of buying Speed Apparel Holding for its dividend, and we'll go through these below.

Explore this interactive chart for our latest analysis on Speed Apparel Holding!

SEHK:3860 Historical Dividend Yield, January 16th 2020

Payout ratios

Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. Looking at the data, we can see that 23% of Speed Apparel Holding's profits were paid out as dividends in the last 12 months. Given the low payout ratio, it is hard to envision the dividend coming under threat, barring a catastrophe.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Of the free cash flow it generated last year, Speed Apparel Holding paid out 38% as dividends, suggesting the dividend is affordable. It's positive to see that Speed Apparel Holding'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.

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

Consider getting our latest analysis on Speed Apparel Holding's financial position here.

Dividend Volatility

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 company has been paying a stable dividend for a few years now, but we'd like to see more evidence of consistency over a longer period. During the past two-year period, the first annual payment was HK$0.015 in 2018, compared to HK$0.016 last year. This works out to be a compound annual growth rate (CAGR) of approximately 3.3% a year over that time.

We like that the dividend hasn't been shrinking. However we're conscious that the company hasn't got an overly long track record of dividend payments yet, which makes us wary of relying on its dividend income.

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 Speed Apparel Holding has been growing its earnings per share at 20% a year over the past five years. Earnings per share are growing at a solid clip, and the payout ratio is low. We think this is an ideal combination in a dividend stock.

We'd also point out that Speed Apparel Holding 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.

Conclusion

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. It's great to see that Speed Apparel Holding is paying out a low percentage of its earnings and cash flow. We were also glad to see it growing earnings, although its dividend history is not as long as we'd like. All things considered, Speed Apparel Holding looks like a strong prospect. At the right valuation, it could be something special.

See if management have their own wealth at stake, by checking insider shareholdings in Speed Apparel Holding stock.

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.