Hengtong Optic-Electric Co., Ltd. (SHSE:600487) stock is about to trade ex-dividend in three days. The ex-dividend date occurs one day before the record date which is the day on which shareholders need to be on the company's books in order to receive a dividend. The ex-dividend date is important because any transaction on a stock needs to have been settled before the record date in order to be eligible for a dividend. This means that investors who purchase Hengtong Optic-Electric's shares on or after the 16th of July will not receive the dividend, which will be paid on the 16th of July.

The company's upcoming dividend is CN¥0.15 a share, following on from the last 12 months, when the company distributed a total of CN¥0.15 per share to shareholders. Looking at the last 12 months of distributions, Hengtong Optic-Electric has a trailing yield of approximately 0.9% on its current stock price of CN¥16.24. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to check whether the dividend payments are covered, and if earnings are growing.

If a company pays out more in dividends than it earned, then the dividend might become unsustainable - hardly an ideal situation. Hengtong Optic-Electric has a low and conservative payout ratio of just 16% of its income after tax. 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 107% of its free cash flow in the form of dividends last year, which is outside the comfort zone for most businesses. Companies usually need cash more than they need earnings - expenses don't pay themselves - so it's not great to see it paying out so much of its cash flow.

Hengtong Optic-Electric paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough cash to cover the dividend. Cash is king, as they say, and were Hengtong Optic-Electric to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

When earnings decline, dividend companies become much harder to analyse and own safely. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. With that in mind, we're discomforted by Hengtong Optic-Electric's 6.8% per annum decline in earnings in the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. Hengtong Optic-Electric has delivered an average of 19% per year annual increase in its dividend, based on the past 10 years of dividend payments.

The Bottom Line

Is Hengtong Optic-Electric an attractive dividend stock, or better left on the shelf? Hengtong Optic-Electric's earnings per share have fallen noticeably and, although it paid out less than half its profit as dividends last year, it paid out a disconcertingly high percentage of its cashflow, which is not a great combination. Bottom line: Hengtong Optic-Electric has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

With that being said, if you're still considering Hengtong Optic-Electric as an investment, you'll find it beneficial to know what risks this stock is facing. For example, we've found 1 warning sign for Hengtong Optic-Electric that we recommend you consider before investing in the business.

If you're in the market for strong dividend payers, we recommend checking our selection of top dividend stocks.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com