Is This Share A Great Dividend Play With Its 6.2% Yield?

Credit: Simon Cunningham

A mistake that happens often with investors when they’re investing for dividends is that they place too much focus on a share’s yield.

That’s a mistake because a share’s dividend yield tells us nothing about what’s important here – the safety and reliability of the company’s dividend.

With this in mind, what should investors make of Metro Holdings Limited (SGX: M01)?

The departmental store operator and part-time property developer and investor has an attractive yield of 6.2% based on its current share price of S$0.97 and its dividend of S$0.06 per share for the financial year ended 31 March 2014 (FY2014).

In comparison, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which closely tracks the fundamentals of Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has a yield of around 2.7% at the moment.

Finding reliable dividends

The following’s certainly not a comprehensive guide, but there are a few things I like to look at when it comes to finding safe yields:

1. A company’s track record in growing and paying its dividend.

This criterion is important because it can give investors insight about management’s commitment to reward shareholders as the business grows.

2. A company’s ability to grow its free cash flow over time and generate it in excess of the dividends paid.

At the end of the day, dividends are paid by a company with the cash it has. That cash can from a few sources: Debt; the issuing of new shares; the sale of assets; and/or the company’s daily business activities.

There are always exceptions, but it’s generally more sustainable for a company to pay its dividends using the cash it has generated from its businesses.

It thus follows that investors should be keeping a close watch on a company’s free cash flow as it is the cash flow from operations that’s left 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

When a company has a weak balance sheet that’s laden with debt, its dividends can be at risk of being reduced or removed – either due to pressure from creditors or from a simple lack of cash – even at the slightest hiccup in the fortunes of its business.

In contrast, a strong balance sheet that is flush with cash gives a company a buffer to help tide over tough times and emerge relatively unscathed.

Piecing the puzzle

Here’s a chart that shows how Metro Holdings has fared against the three criteria over its past 10 completed-financial years:

Metro Holdings' historical financials

Source: S&P Capital IQ

It’s been a mixed bag for the company. While it has been paying consistent dividends between FY2004 and FY2014, there’s no clear sign of growth. Its balance sheet has remained reasonably strong with cash largely been higher than debt throughout those years, but it has had a poor track record with merely generating free cash flow, much less growing it.

It’s also worth pointing out that the firm’s dividends have largely been higher than its free cash flow.

A Fool’s take

There are things to like about Metro Holdings’ financials (its fairly strong balance sheet and record of paying a consistent dividend) but it does have its fair share of warts as well (the lack of free cash flow and the inability to grow its dividends).

On the balance though, it seems to me that Metro Holdings may not make for a particularly attractive dividend play despite its high yield.

But that said, we should note that this look at Metro Holdings’ financial history is certainly not a holistic overview of the entire picture. To arrive at a better conclusion on Metro Holdings’ investing merits, investors should still spend time digging through the qualitative aspects of the retailer’s business and figure out if brighter or gloomier days are ahead.

Understanding the history of a company is important. But investors should never invest by looking solely at the rear-view mirror.

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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 company mentioned.