Is This Company a Great Dividend Share with Its Yield Of 6.5%?

It might not be uncommon to find shares with high dividend yields of 6% or above.

But, it can be dangerous to invest in a share just because it has a high dividend yield – after all, a share’s yield tells us nothing about how safe or reliable its dividend is.

Keeping this in mind, what should investors make of King Wan Corporation Ltd (SGX: 554)?

King Wan’s a provider of mechanical and electrical engineering services to the building and construction industry. Based on its dividend for the fiscal year ended 31 March 2014 (FY2014) and its current share price of S$0.31, King Wan has an attractive yield of 6.5% at the moment.

In contrast, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks Singapore’s market benchmark, the Straits Times Index (SGX: ^STI) – has a yield of just 2.7%.

The makings of a strong dividend

The following’s certainly not a complete list, but they are some of the things I like to know when searching for a strong dividend share:

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

This is important for the insight it can give investors 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.

Dividends are ultimately paid with the cash a company has and that cash can come from a few sources: Debt; the issuing of new shares; the sale of assets; and/or the company’s daily business operations.

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

Having a weak balance sheet that’s laden with debt puts a company’s dividend at risk of being cut or removed – either due to pressure from creditors or the simple lack of cash – if there are even any slight hiccups in the business.

On the flipside, the possession of a strong balance sheet that is flush with cash allows a company to tide over rough times and emerge unscathed.

Piecing the puzzle

The chart below shows how King Wan has fared against the three criteria over its past 10 completed fiscal years:

King Wan's historical financials

Source: S&P Capital IQ

Over the 10-year period under study, King Wan has managed to grow its dividend considerably if we take FY2005 as the starting point. But crucially, the firm has not paid its dividends consistently (for instance there was no dividend in 2009).

In addition, the firm’s dividends have had a tendency to swing wildly although it may not be that noticeable in the chart due to the number scale used; in 2006, King Wan’s dividends fell by 50% from 0.15 Singapore cents per share in 2005 to 0.075 cents per share.

Moving on to the company’s historical free cash flows, there’s no consistency nor any sign of persistent growth in that important financial metric. These – along with the company’s erratic dividend – point to a firm that may have a very cyclical business.

As for the balance sheet, the company has mostly carried more debt than cash – that’s not exactly a sign of a strong balance sheet.

A Fool’s take

Given what we’ve seen, there isn’t much to like about King Wan besides its high dividend yield and growth in dividends over the past five years from FY2010 to FY2014.

But that said, it’s important to point out that this long look at King Wan’s historical financials isn’t a holistic overview of the overall picture. We’d need to dig deeper into the qualitative aspects of its business and figure out if better days are ahead in order to come out with a better conclusion on the company’s investing merits (or lack thereof).

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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.