The Hong Kong and China Gas Company Limited (HKG:3) stock is about to trade ex-dividend in three 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. Thus, you can purchase Hong Kong and China Gas' shares before the 29th of August in order to receive the dividend, which the company will pay on the 11th of September.

The company's upcoming dividend is HK$0.12 a share, following on from the last 12 months, when the company distributed a total of HK$0.35 per share to shareholders. Based on the last year's worth of payments, Hong Kong and China Gas stock has a trailing yield of around 5.6% on the current share price of HK$6.30. 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 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. Hong Kong and China Gas distributed an unsustainably high 119% of its profit as dividends to shareholders last year. Without more sustainable payment behaviour, the dividend looks precarious. A useful secondary check can be to evaluate whether Hong Kong and China Gas generated enough free cash flow to afford its dividend. It paid out an unsustainably high 254% of its free cash flow as dividends over the past 12 months, which is worrying. Unless there were something in the business we're not grasping, this could signal a risk that the dividend may have to be cut in the future.

Cash is slightly more important than profit from a dividend perspective, but given Hong Kong and China Gas's payouts were not well covered by either earnings or cash flow, we would be 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?

Companies with falling earnings are riskier for dividend shareholders. If earnings fall far enough, the company could be forced to cut its dividend. Hong Kong and China Gas's earnings per share have fallen at approximately 10% a year over the previous five years. When earnings per share fall, the maximum amount of dividends that can be paid also falls.

The main way most investors will assess a company's dividend prospects is by checking the historical rate of dividend growth. In the past 10 years, Hong Kong and China Gas has increased its dividend at approximately 6.9% a year on average. That's intriguing, but the combination of growing dividends despite declining earnings can typically only be achieved by paying out a larger percentage of profits. 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.

Final Takeaway

Has Hong Kong and China Gas got what it takes to maintain its dividend payments? Not only are earnings per share declining, but Hong Kong and China Gas is paying out an uncomfortably high percentage of both its earnings and cashflow to shareholders 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 that we think Hong Kong and China Gas is a bad company, but these characteristics don't generally lead to outstanding dividend performance.

Although, if you're still interested in Hong Kong and China Gas and want to know more, you'll find it very useful to know what risks this stock faces. Our analysis shows 2 warning signs for Hong Kong and China Gas and you should be aware of them before buying any shares.

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.