Shanxi Huhua Group Co., Ltd. (SZSE:003002) stock is about to trade ex-dividend in 4 days. Typically, the ex-dividend date is one business day before the record date which is the date on which a company determines the shareholders eligible to receive a dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade takes at least two business day to settle. Meaning, you will need to purchase Shanxi Huhua Group's shares before the 29th of May to receive the dividend, which will be paid on the 29th of May.

The company's next dividend payment will be CN¥0.25 per share, and in the last 12 months, the company paid a total of CN¥0.15 per share. Last year's total dividend payments show that Shanxi Huhua Group has a trailing yield of 1.2% on the current share price of CN¥12.65. If you buy this business for its dividend, you should have an idea of whether Shanxi Huhua Group's dividend is reliable and sustainable. So we need to check whether the dividend payments are covered, and if earnings are growing.

Dividends are typically paid from company earnings. If a company pays more in dividends than it earned in profit, then the dividend could be unsustainable. Shanxi Huhua Group paid out just 16% of its profit last year, which we think is conservatively low and leaves plenty of margin for unexpected circumstances. Yet cash flows are even more important than profits for assessing a dividend, so we need to see if the company generated enough cash to pay its distribution. It paid out 80% of its free cash flow as dividends, which is within usual limits but will limit the company's ability to lift the dividend if there's no growth.

It's positive to see that Shanxi Huhua Group'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.

Click here to see how much of its profit Shanxi Huhua Group paid out over the last 12 months.

Have Earnings And Dividends Been Growing?

Stocks in companies that generate sustainable earnings growth often make the best dividend prospects, as it is easier to lift the dividend when earnings are rising. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. It's encouraging to see Shanxi Huhua Group has grown its earnings rapidly, up 24% a year for the past five years.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Shanxi Huhua Group has seen its dividend decline 28% per annum on average over the past three years, which is not great to see. Shanxi Huhua Group is a rare case where dividends have been decreasing at the same time as earnings per share have been improving. It's unusual to see, and could point to unstable conditions in the core business, or more rarely an intensified focus on reinvesting profits.

The Bottom Line

Should investors buy Shanxi Huhua Group for the upcoming dividend? Earnings per share have grown at a nice rate in recent times and over the last year, Shanxi Huhua Group paid out less than half its earnings and a bit over half its free cash flow. Overall we think this is an attractive combination and worthy of further research.

While it's tempting to invest in Shanxi Huhua Group for the dividends alone, you should always be mindful of the risks involved. Case in point: We've spotted 2 warning signs for Shanxi Huhua Group you should be aware of.

Generally, we wouldn't recommend just buying the first dividend stock you see. Here's a curated list of interesting stocks that are strong dividend payers.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.