Is This Share’s 8% Dividend Yield Too Good to Be True?

It’s not that uncommon to find shares with high dividend yields in Singapore as a trip to the free stock-screener provided by stock exchange operator Singapore Exchange can attest.

But, there are high-yielding shares with yields that are simply too good to be true – these are shares which would eventually result in a bad overall experience for investors because of subsequent poor business performances.

With these in mind, what should investors make of Soilbuild Construction Group Ltd (SGX: S7P)?

The construction outfit has a very attractive dividend yield of 8% based on its current share price of S$0.25 and its annual dividend of S$0.02 per share for 2014.

In comparison, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund which tracks the market barometer, the Straits Times Index (SGX: ^STI) – has a yield of just 2.8% at the moment.

What strong yields are made of

The following’s certainly not a complete guide, but they are some of the things I like to look at when I’m trying to find safe yields:

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

The importance of this criterion lies in 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 by a company with the cash it has. This 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.

Although there are always exceptions, 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 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 in their current state.

3. The strength of the company’s balance sheet.

A company that has a weak balance sheet laden with debt finds its dividends at risk of being cut or removed completely – either due to pressure from creditors or a simple lack of cash – if there are even just slight hiccups in the business.

On the flipside, having a strong balance sheet that is flush with cash puts a company in good stead to tide over tough times and emerge unscathed.

Pulling everything together

Here’s a chart showing how Soilbuild Construction has fared against the three criteria from 2010 to 2014 (the company was listed only in May 2013 and so historical data about the firm goes back to only 2010):

Soilbuild Construction's historical financials

Source: S&P Capital IQ

At first glance, there are a number of things to like about Soilbuild Construction’s financials.

The company paid a dividend of S$0.015 per share in the same year that it listed; in 2014, that dividend got a nice 33% bump up to S$0.02 per share. In addition, the firm has a strong balance sheet that has S$51.2 million in cash and no debt.

But, there are also things in Soilbuild Construction’s financials that may warrant concern from investors.

For instance, the firm has had a spotty track record with generating free cash flow over the period from 2010 to 2014.

Also, Soilbuild’s balance sheet wasn’t exactly strong prior to its listing; this suggests that the company’s much-improved balance sheet in 2013 had partly been the result of an inflow of capital from its IPO.

Given that (1) the firm’s balance sheet has deteriorated rather significantly in 2014 (as seen from the decline in the cash position from 2013’s levels), and (2) the firm’s inability to generate free cash flow consistently, there’s a risk that the construction outfit’s balance sheet may weaken in the future.

A Fool’s take

Although there’re strengths to Soilbuild Construction’s financials, there are also clouds of uncertainty hanging over it.

Taking into consideration the firm’s spotty free cash flows and the risk of a balance sheet that may weaken considerably over time, there’s a chance that Soilbuild Construction’s high dividend yield of 8% may be too good to be true.

But that said, this look at Soilbuild Construction’s historical financials isn’t a holistic view of the overall picture with the company. To arrive at a stronger conclusion on the firm’s investing merits, investors would have to spend more time digging through the qualitative aspects of the company’s business and figure out if better days are head.

A look back at history can be important and informative, but investors should never invest purely be peering into the rearview 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.