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The Danger with High-Yielding Dividend Shares

For investors who would like to obtain dividends by investing in Singapore’s share market as a whole, one of the easiest ways would be to invest in the SPDR Straits Times Index ETF (SGX: ES3), an exchange-traded fund that tracks Singapore’s share market barometer, the Straits Times Index (SGX: ^STI).

At the index’s current level of around 3,280 points, the ETF has a dividend yield of approximately 2.7%. Unfortunately, that’s not a very exciting yield, which might lead to some investors chasing after higher-yielding shares for larger immediate income.

With a dividend of S$0.01 per share for the financial year ended 30 April 2013 (FY2013), steel trader and tinplate manufacturer Novo Group (SGX: MR8) would have a trailing dividend yield of 7.1% at its current share price of S$0.14. That’s a yield that looks very attractive in relation to the broader market at first glance. But, there can be risks that underlie such high-yielding shares.

Dividends are ultimately paid by a company using cash but that is something which the company has trouble generating of late, as seen in the table below.

Year ended 30 April

Operating cash flow

2008

-S$2.8 million

2009

-S$1.0 million

2010

-S$8.4 million
2011

S$8.4 million

2012

S$8.0 million

2013

-S$30.6 million

Last 12 months

S$0.6 million

Source: S&P Capital IQ

Without an ability to consistently generate operating cash flow, it’d be tough for the company to invest into its own businesses without having to dip into its coffers and/or assume more debt. That’s what has happened with Novo as seen from how its net debt position (total debt minus total cash & short-term investments) had steadily increased over the years. It’s not a situation that’s healthy for investors as an increase in leverage would entail the company taking on more financial risks.

Year ended 30 April

Net debt*

2008

-S$24 million

2009

-S$21 million

2010

-S$11 million
2011

-S$13 million

2012

-S$7 million

2013

S$60 million

Last 12 months

S$66.3 million

*A negative figure would mean the company has more cash than debt.

Source: S&P Capital IQ

Generally speaking, companies that find it tough to generate consistent operating cash flow and yet take on more debt can often cut or decrease their dividend in a bid to conserve cash. With that in mind, it’s easy to see how the dividends of Novo do come with some risks; interestingly, dividends at Novo have dropped from S$0.04 per share in FY2010 to S$0.01 in FY2013.

This is not meant to say that the company would necessarily make for a bad investment. Rather, this exercise is meant to point out some important factors that investors interested in high-yielding shares ought to look out for.

When it comes to dividends, yields are not the only thing that investors should focus on.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.