Some investors rely on dividends for growing their wealth, and if you're one of those dividend sleuths, you might be intrigued to know that Zhejiang Chinastars New Materials Group Co., Ltd. (SZSE:301077) is about to go ex-dividend in just two days. The ex-dividend date is one business day before a company's record date, which is the date on which the company determines which shareholders are entitled 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. In other words, investors can purchase Zhejiang Chinastars New Materials Group's shares before the 17th of October in order to be eligible for the dividend, which will be paid on the 17th of October.

The company's next dividend payment will be CN¥0.30 per share, on the back of last year when the company paid a total of CN¥0.60 to shareholders. Last year's total dividend payments show that Zhejiang Chinastars New Materials Group has a trailing yield of 3.1% on the current share price of CN¥19.39. If you buy this business for its dividend, you should have an idea of whether Zhejiang Chinastars New Materials Group's dividend is reliable and sustainable. That's why we should always check whether the dividend payments appear sustainable, and if the company is growing.

Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. It paid out 84% of its earnings as dividends last year, which is not unreasonable, but limits reinvestment in the business and leaves the dividend vulnerable to a business downturn. We'd be worried about the risk of a drop in earnings. A useful secondary check can be to evaluate whether Zhejiang Chinastars New Materials Group generated enough free cash flow to afford its dividend. Zhejiang Chinastars New Materials Group paid out more free cash flow than it generated - 111%, to be precise - last year, which we think is concerningly high. We're curious about why the company paid out more cash than it generated last year, since this can be one of the early signs that a dividend may be unsustainable.

Zhejiang Chinastars New Materials Group does have a large net cash position on the balance sheet, which could fund large dividends for a time, if the company so chose. Still, smart investors know that it is better to assess dividends relative to the cash and profit generated by the business. Paying dividends out of cash on the balance sheet is not long-term sustainable.

While Zhejiang Chinastars New Materials Group's dividends were covered by the company's reported profits, cash 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 Zhejiang Chinastars New Materials Group to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

Click here to see how much of its profit Zhejiang Chinastars New Materials Group paid out over the last 12 months.

Have Earnings And Dividends Been Growing?

Businesses with strong growth prospects usually make the best dividend payers, because it's easier to grow dividends when earnings per share are improving. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. That's why it's comforting to see Zhejiang Chinastars New Materials Group's earnings have been skyrocketing, up 20% per annum for the past five years. Earnings have been growing quickly, but we're concerned dividend payments consumed most of the company's cash flow over the past year.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Zhejiang Chinastars New Materials Group's dividend payments per share have declined at 23% per year on average over the past two years, which is uninspiring. Zhejiang Chinastars New Materials 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.

Final Takeaway

From a dividend perspective, should investors buy or avoid Zhejiang Chinastars New Materials Group? It's good to see that earnings per share are growing and that the company's payout ratio is within a normal range for most businesses. However we're somewhat concerned that it paid out 111% of its cashflow, which is uncomfortably high. While it does have some good things going for it, we're a bit ambivalent and it would take more to convince us of Zhejiang Chinastars New Materials Group's dividend merits.

However if you're still interested in Zhejiang Chinastars New Materials Group as a potential investment, you should definitely consider some of the risks involved with Zhejiang Chinastars New Materials Group. Case in point: We've spotted 1 warning sign for Zhejiang Chinastars New Materials Group you should be aware of.

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

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