Readers hoping to buy Lam Soon (Hong Kong) Limited (HKG:411) for its dividend will need to make their move shortly, as the stock is about to trade ex-dividend. 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. In other words, investors can purchase Lam Soon (Hong Kong)'s shares before the 16th of November in order to be eligible for the dividend, which will be paid on the 5th of December.

The company's next dividend payment will be HK$0.20 per share, on the back of last year when the company paid a total of HK$0.30 to shareholders. Based on the last year's worth of payments, Lam Soon (Hong Kong) stock has a trailing yield of around 3.8% on the current share price of HK$8. If you buy this business for its dividend, you should have an idea of whether Lam Soon (Hong Kong)'s dividend is reliable and sustainable. We need to see whether the dividend is covered by earnings and if it's growing.

See our latest analysis for Lam Soon (Hong Kong)

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 83% 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 concerned if earnings began to decline. Yet cash flow is typically more important than profit for assessing dividend sustainability, so we should always check if the company generated enough cash to afford its dividend. The company paid out 92% of its free cash flow over the last year, which we think is outside the ideal range for most businesses. Cash flows are usually much more volatile than earnings, so this could be a temporary effect - but we'd generally want to look more closely here.

While Lam Soon (Hong Kong)'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 Lam Soon (Hong Kong) 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 Lam Soon (Hong Kong) paid out over the last 12 months.

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. With that in mind, we're discomforted by Lam Soon (Hong Kong)'s 23% 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.

Many investors will assess a company's dividend performance by evaluating how much the dividend payments have changed over time. In the past 10 years, Lam Soon (Hong Kong) has increased its dividend at approximately 9.6% 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. Lam Soon (Hong Kong) is already paying out 83% of its profits, and with shrinking earnings we think it's unlikely that this dividend will grow quickly in the future.

The Bottom Line

From a dividend perspective, should investors buy or avoid Lam Soon (Hong Kong)? It's definitely not great to see earnings per share shrinking. The company paid out an acceptable percentage of its income, but an uncomfortably high percentage of its cash flow over the past year. Bottom line: Lam Soon (Hong Kong) has some unfortunate characteristics that we think could lead to sub-optimal outcomes for dividend investors.

Having said that, if you're looking at this stock without much concern for the dividend, you should still be familiar of the risks involved with Lam Soon (Hong Kong). Be aware that Lam Soon (Hong Kong) is showing 3 warning signs in our investment analysis, and 1 of those is significant...

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.