When it comes to investing for dividends, a common mistake amongst investors would be a focus on a share’s yield alone. But, that can be dangerous since a share’s future dividend – which is what’s important to us as investors – is entirely dependent upon the strength of its business performance in the years ahead. Looking at a share’s yield alone gives us no real information at all about what’s important. Some helpful signs On that note, here are some useful clues which can help point us toward rock-solid dividend shares:
1. The company’s track record of growing…
When it comes to investing for dividends, a common mistake amongst investors would be a focus on a share’s yield alone.
But, that can be dangerous since a share’s future dividend – which is what’s important to us as investors – is entirely dependent upon the strength of its business performance in the years ahead. Looking at a share’s yield alone gives us no real information at all about what’s important.
Some helpful signs
On that note, here are some useful clues which can help point us toward rock-solid dividend shares:
1. The company’s track record of growing its dividends:
This is important as it gives investors valuable insight on management’s commitment to reward investors as the company grows. As New York University finance professor Aswath Damodaran once said, “Dividends are like getting married; stock buybacks are like hooking up.”
2. The company’s ability to grow its free cash flow and generate free cash flow in excess of dividends paid:
Dividends are ultimately paid with the cash a company has. That cash can come from a few sources: Borrowings; issuance of new shares; and/or from the company’s daily business operations.
There can always be exceptions. But it’s generally more sustainable for a company to be paying its dividends using the cash generated from its businesses.
It thus follows that investors should be keeping an eye on a company’s free cash flow as it’s the cash flow from operations that remains after the firm has spent the necessary capital needed to maintain its businesses at their current state.
3. The strength of the company’s balance sheet:
Companies that have weak balance sheets that are laden with debt generally face higher financial risks. Any slight hiccup in their businesses or in the general economic environment (such as a rise in interest rates) may have negative impacts on their dividends.
A strong balance sheet that is flush with cash provides a buffer against tough times and gives a company room for error.
With all these in mind, inspection and testing outfit Vicom Limited (SGX: V01) could be a rock-solid dividend share.
The rock (solid) star
The company had released its fiscal fourth quarter earnings yesterday evening for 2014 (the company’s fiscal year coincides with the calendar year) and declared final and special dividends which totaled 18.25 Singapore cents per share.
Together with an interim dividend of 8.75 cents per share declared in the second quarter of 2014, these bring Vicom’s annual dividend for 2014 to 27 cents per share and marks the firm’s sixth consecutive year of annual dividend increases. You can see this in the table below:
Source: S&P Capital IQ and Vicom’s earnings release; *includes special dividends
Although Vicom’s dividends have not grown in each year like clockwork since 2003, there’s still an unmistakable upward trend over those past 11 years.
Vicom’s latest earnings release also saw it generating S$32.65 million in free cash flow for the whole of 2014, up by 14.3% from S$28.56 million seen a year ago. As for the balance sheet, the company ended 2014 with S$91 million in cash and zero debt; that’s a marked improvement from a year ago when cash was just S$78.5 million (debt was zero too back then).
For a longer-term perspective on how Vicom’s free cash flow and balance sheet had looked like, check out the chart below (it also plots Vicom’s dividends so we can have a sense of how the dividends compares with free cash flow):
Source: S&P Capital IQ and Vicom’s earnings release
As you can see, Vicom’s free cash flow has not only been growing steadily over the past 11 years since 2003 – it’s also largely been higher than the dividends paid. The balance sheet statistics are even more impressive with Vicom having been debt-free since 2005.
A Fool’s take
Vicom has certainly checked off some of the right-boxes when it comes to being a great dividend share.
The company’s solid trailing-12-month dividend yield of 4.1% (based on a current share price of S$6.52) can also be a sweetener to the deal. For some perspective, the SDPR STI ETF (SGX: ES3) – an exchange-traded fund tracking Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has a yield of just 2.7%.
But all that said, there are still important considerations for investors to think about with Vicom.
For instance, the company’s top-line growth has been slowing down in recent years (revenue growth was 8.1% in 2011; in 2014, it was just 3.0%). This could be a sign that Vicom’s finding it tough to continue growing its business.
Investors would need to weigh the risks and rewards with this share in order to come up with an intelligent investing decision.
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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 owns shares in Vicom Limited.