It looks like The Hong Kong and China Gas Company Limited (HKG:3) is about to go ex-dividend in the next three days. The ex-dividend date is usually set to be one business day before the record date which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the 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. Accordingly, Hong Kong and China Gas investors that purchase the stock on or after the 6th of June will not receive the dividend, which will be paid on the 24th of June.

The company's next dividend payment will be HK$0.23 per share, and in the last 12 months, the company paid a total of HK$0.35 per share. Based on the last year's worth of payments, Hong Kong and China Gas has a trailing yield of 5.8% on the current stock price of HK$6.07. Dividends are an important source of income to many shareholders, but the health of the business is crucial to maintaining those dividends. So we need to investigate whether Hong Kong and China Gas can afford its dividend, and if the dividend could grow.

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. Last year, Hong Kong and China Gas paid out 108% of its income as dividends, which is above a level that we're comfortable with, especially if the company needs to reinvest in its business. 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 an unsustainably high 254% of its free cash flow as dividends over the past 12 months, which is worrying. Our definition of free cash flow excludes cash generated from asset sales, so since Hong Kong and China Gas is paying out such a high percentage of its cash flow, it might be worth seeing if it sold assets or had similar events that might have led to such a high dividend payment.

Cash is slightly more important than profit from a dividend perspective, but given Hong Kong and China Gas's payments were not well covered by either earnings or cash flow, we are concerned about the sustainability of this dividend.

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. Investors love dividends, so if earnings fall and the dividend is reduced, expect a stock to be sold off heavily at the same time. Readers will understand then, why we're concerned to see Hong Kong and China Gas's earnings per share have dropped 8.2% a year over the past five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. Hong Kong and China Gas has delivered an average of 6.9% per year annual increase in its dividend, based on the past 10 years of dividend payments. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Hong Kong and China Gas is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.

The Bottom Line

Is Hong Kong and China Gas worth buying for its dividend? It's looking like an unattractive opportunity, with its earnings per share declining, while, paying out an uncomfortably high percentage of both its profits (108%) and cash flow as dividends. This is a clearly suboptimal combination that usually suggests the dividend is at risk of being cut. If not now, then perhaps in the future. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

So if you're still interested in Hong Kong and China Gas despite it's poor dividend qualities, you should be well informed on some of the risks facing this stock. In terms of investment risks, we've identified 2 warning signs with Hong Kong and China Gas and understanding them should be part of your investment process.

A common investing mistake is buying the first interesting stock you see. Here you can find a full list of high-yield 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.