Should Zhongzhi Pharmaceutical Holdings Limited (HKG:3737) Be Part Of Your Dividend Portfolio?

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Simply Wall St

Wed, Sep 25, 2019, 11:09 PM

Is Zhongzhi Pharmaceutical Holdings Limited (HKG:3737) a good dividend stock? How can we tell? Dividend paying companies with growing earnings can be highly rewarding in the long term. 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.

Zhongzhi Pharmaceutical Holdings yields a solid 5.9%, although it has only been paying for three years. A 5.9% yield does look good. Could the short payment history hint at future dividend growth? When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Explore this interactive chart for our latest analysis on Zhongzhi Pharmaceutical Holdings!

SEHK:3737 Historical Dividend Yield, September 26th 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. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Looking at the data, we can see that 40% of Zhongzhi Pharmaceutical Holdings's profits were paid out as dividends in the last 12 months. This is a middling range that strikes a nice balance between paying dividends to shareholders, and retaining enough earnings to invest in future growth. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.

Another important check we do is to see if the free cash flow generated is sufficient to pay the dividend. Zhongzhi Pharmaceutical Holdings paid out a conservative 44% of its free cash flow as dividends last year. It's positive to see that Zhongzhi Pharmaceutical Holdings'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 Zhongzhi Pharmaceutical Holdings's strong net cash position, which will let it pay larger dividends for a time, should it choose.

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

Dividend Volatility

Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. This company's dividend has been unstable, and with a relatively short history, we think it's a little soon to draw strong conclusions about its long term dividend potential. During the past three-year period, the first annual payment was CN¥0.029 in 2016, compared to CN¥0.074 last year. This works out to be a compound annual growth rate (CAGR) of approximately 36% a year over that time. Zhongzhi Pharmaceutical Holdings's dividend payments have fluctuated, so it hasn't grown 36% every year, but the CAGR is a useful rule of thumb for approximating the historical growth.

So, its dividends have grown at a rapid rate over this time, but payments have been cut in the past. The stock may still be worth considering as part of a diversified dividend portfolio.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. Zhongzhi Pharmaceutical Holdings's earnings per share have been essentially flat over the past three years. Over the long term, steady earnings per share is a risk as the value of the dividends can be reduced by inflation. A payout ratio below 50% leaves ample room to reinvest in the business, and provides finanical flexibility. However, earnings per share are unfortunately not growing much. Might this suggest that the company should pay a higher dividend instead?

We'd also point out that Zhongzhi Pharmaceutical Holdings 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. Firstly, we like that Zhongzhi Pharmaceutical Holdings has low and conservative payout ratios. Unfortunately, the company has not been able to generate earnings growth, and cut its dividend at least once in the past. Overall we think Zhongzhi Pharmaceutical Holdings is an interesting dividend stock, although it could be better.

You can also discover whether shareholders are aligned with insider interests by checking our visualisation of insider shareholdings and trades in Zhongzhi Pharmaceutical Holdings stock.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 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.

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