Dividend paying stocks like Chemfab Alkalis Limited (NSE:CHEMFABALKA) 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. 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.

Some readers mightn't know much about Chemfab Alkalis's 0.8% dividend, as it has only been paying distributions for a year or so. Some simple analysis can reduce the risk of holding Chemfab Alkalis for its dividend, and we'll focus on the most important aspects below.

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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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. In the last year, Chemfab Alkalis paid out 10.0% of its profit as dividends. 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. Unfortunately, while Chemfab Alkalis pays a dividend, it also reported negative free cash flow last year. While there may be a good reason for this, it's not ideal from a dividend perspective.

Remember, you can always get a snapshot of Chemfab Alkalis's latest financial position, by checking our visualisation of its financial health.

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. With a payment history of less than 2 years, we think it's a bit too soon to think about living on the income from its dividend. Its most recent annual dividend was ₹1.25 per share.

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

Examining whether the dividend is affordable and stable is important. However, it's also important to assess if earnings per share (EPS) are growing. Growing EPS can help maintain or increase the purchasing power of the dividend over the long run. Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see Chemfab Alkalis has grown its earnings per share at 71% per annum over the past five years. Earnings per share have grown rapidly, and the company is retaining a majority of its earnings. We think this is ideal from an investment perspective, if the company is able to reinvest these earnings effectively.