Dividend paying stocks like Sanbase Corporation Limited (HKG:8501) 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. 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.
In this case, Sanbase pays a decent-sized 6.7% dividend yield, and has been distributing cash to shareholders for the past two years. It’s certainly an attractive yield, but readers are likely curious about its staying power. The company also bought back stock equivalent to around 3.3% 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.
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. Looking at the data, we can see that 27% of Sanbase’s profits were paid out as dividends in the last 12 months. This is a medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.
We also measure dividends paid against a company’s levered free cash flow, to see if enough cash was generated to cover the dividend. Sanbase’s cash payout ratio last year was 11%. Cash flows are typically lumpy, but this looks like an appropriately conservative payout. It’s encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don’t drop precipitously.
With a strong net cash balance, Sanbase investors may not have much to worry about in the near term from a dividend perspective.
Remember, you can always get a snapshot of Sanbase’s latest financial position, by checking our visualisation of its financial health.
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. 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$0.024 in 2018, compared to HK$0.031 last year. Dividends per share have grown at approximately 14% per year over this time.
The dividend has been growing pretty quickly, which could be enough to get us interested even though the dividend history is relatively short. Further research may be warranted.
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. Sanbase’s earnings per share are up 124% on last year. We’re glad to see EPS up on last year, but we’re conscious that growth rates typically slow as companies increase in size. Earnings per share have rocketed in recent times, and we like that the company is retaining more than half of its earnings to reinvest. However, always remember that very few companies can grow at double digit rates forever. We do note though, one year is too short a time to be drawing strong conclusions about a company’s future prospects.
To summarise, shareholders should always check that Sanbase’s dividends are affordable, that its dividend payments are relatively stable, and that it has decent prospects for growing its earnings and dividend. Firstly, we like that Sanbase has low and conservative payout ratios. We were also glad to see it growing earnings, although its dividend history is not as long as we’d like. All things considered, Sanbase looks like a strong prospect. At the right valuation, it could be something special.
It’s important to note that companies having a consistent dividend policy will generate greater investor confidence than those having an erratic one. Still, investors need to consider a host of other factors, apart from dividend payments, when analysing a company. For instance, we’ve picked out 3 warning signs for Sanbase that investors should take into consideration.
If you are a dividend investor, you might also want to look at our curated list of dividend stocks yielding above 3%.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.