Dividend paying stocks like BYD Electronic (International) Company Limited (HKG:285) 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 popular dividend stock because of its yield, and then lose money if the company's dividend doesn't live up to expectations.
A 1.4% yield is nothing to get excited about, but investors probably think the long payment history suggests BYD Electronic (International) has some staying power. There are a few simple ways to reduce the risks of buying BYD Electronic (International) for its dividend, and we'll go through these below.
SEHK:285 Historical Dividend Yield, December 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. Comparing dividend payments to a company's net profit after tax is a simple way of reality-checking whether a dividend is sustainable. BYD Electronic (International) paid out 27% of its profit as dividends, over the trailing twelve month period. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. BYD Electronic (International) paid out 447% of its free cash flow last year, suggesting the dividend is poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. While BYD Electronic (International)'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. Cash is king, as they say, and were BYD Electronic (International) to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.
With a strong net cash balance, BYD Electronic (International) investors may not have much to worry about in the near term from a dividend perspective.
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. BYD Electronic (International) has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. This dividend has been unstable, which we define as having fallen by at least 20% one or more times over this time. During the past ten-year period, the first annual payment was CN¥0.067 in 2009, compared to CN¥0.20 last year. Dividends per share have grown at approximately 11% per year over this time. The dividends haven't grown at precisely 11% every year, but this is a useful way to average out the historical rate of growth.
It's not great to see that the payment has been cut in the past. We're generally more wary of companies that have cut their dividend before, as they tend to perform worse in an economic downturn.
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? Strong earnings per share (EPS) growth might encourage our interest in the company despite fluctuating dividends, which is why it's great to see BYD Electronic (International) has grown its earnings per share at 20% per annum over the past five years. With high earnings per share growth in recent times and a modest payout ratio, we think this is an attractive combination if earnings can be reinvested to generate further growth.
Conclusion
Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Firstly, the company has a conservative payout ratio, although we'd note that its cashflow in the past year was substantially lower than its reported profit. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. In sum, we find it hard to get excited about BYD Electronic (International) from a dividend perspective. It's not that we think it's a bad business; just that there are other companies that perform better on these criteria.
Earnings growth generally bodes well for the future value of company dividend payments. See if the 14 BYD Electronic (International) analysts we track are forecasting continued growth with our freereport on analyst estimates for the company.
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.
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