Today we'll take a closer look at Sitoy Group Holdings Limited (HKG:1023) 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. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.

In this case, Sitoy Group Holdings likely looks attractive to dividend investors, given its 9.4% dividend yield and seven-year payment history. We'd agree the yield does look enticing. The company also bought back stock equivalent to around 9.3% of market capitalisation this year. 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.

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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. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Sitoy Group Holdings paid out 52% of its profit as dividends. This is a fairly normal payout ratio among most businesses. It allows a higher dividend to be paid to shareholders, but does limit the capital retained in the business - which could be good or bad.

In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Sitoy Group Holdings paid out 134% of its free cash flow last year, which we think is concerning if cash flows do not improve. 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 Sitoy Group Holdings'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 Sitoy Group Holdings to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Consider getting our latest analysis on Sitoy Group Holdings'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. Sitoy Group Holdings has been paying a dividend for the past seven years. It's good to see that Sitoy Group Holdings has been paying a dividend for a number of years. However, the dividend has been cut at least once in the past, and we're concerned that what has been cut once, could be cut again. During the past seven-year period, the first annual payment was HK$0.20 in 2012, compared to HK$0.12 last year. The dividend has shrunk at around 7.0% a year during that period. Sitoy Group Holdings's dividend has been cut sharply at least once, so it hasn't fallen by 7.0% every year, but this is a decent approximation of the long term change.

A shrinking dividend over a seven-year period is not ideal, and we'd be concerned about investing in a dividend stock that lacks a solid record of growing dividends per share.

Dividend Growth Potential

Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. Sitoy Group Holdings's EPS have fallen by approximately 11% per year. With this kind of significant decline, we always wonder what has changed in the business. Dividends are about stability, and Sitoy Group Holdings's earnings per share, which support the dividend, have been anything but stable.

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. First, we think Sitoy Group Holdings has an acceptable payout ratio, although its dividend was not well covered by cashflow. Unfortunately, the company has not been able to generate earnings per share growth, and cut its dividend at least once in the past. Using these criteria, Sitoy Group Holdings looks quite suboptimal from a dividend investment perspective.

Are management backing themselves to deliver performance? Check their shareholdings in Sitoy Group Holdings in our latest insider ownership analysis.

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

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.

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. Thank you for reading.