This Share with a Tiny 2.2% Yield May Still Be a Great Dividend Play

Mention the term “a good dividend share” and a high yield would likely come to the mind of most investors.

But, low-yielding shares may still turn out to be attractive income-generating investments for us – what matters here is the firm’s future growth in dividends.

Creating the dividend shares of tomorrow

When it comes to finding shares which may deliver strong yields in the years to come, there are a few things I like to dig into:

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.

Pulling it all together

Keeping all the above in mind, there’re reasons to think that tourism asset operator Straco Corporation Ltd (SGX: S85) may still be a great dividend share despite its low yield.

At Straco’s current share price of S$0.91, it has a meagre dividend yield of just 2.2% based on its dividend of S$0.02 per share for the whole of 2014.

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

The chart below shows how Straco has fared against the three important financial characteristics I described earlier:

Straco's historical financials

Source: S&P Capital IQ

Over the past decade between 2004 and 2014, Straco has seen its dividends and free cash flow climb unmistakably upward. In addition, the free cash flow generated has consistently been higher than the firm’s dividends.

I trust it’s obvious to see too that the company’s balance sheet has been really strong throughout the years under study with the amount of cash far exceeding the level of borrowings. 2014 saw Straco take on a huge chunk of debt, but that was done mostly to finance the firm’s purchase of the Singapore Flyer in November of that year.

A Fool’s take

If Straco can continue its strong historical financial performance into the future, the firm may just be able to reward shareholders with a stream of growing dividends in the years ahead.

But, that’s a really big if. Investors should note that this look at Straco’s past finances is certainly not a holistic overview of the entire picture.

To get to a better conclusion on Straco’s investment merits, investors would have to spend time digging through the qualitative aspects of the firm’s business and consider if there really are brighter days ahead.

An understanding of a firm’s history is important and informative, but investors shouldn’t invest by looking purely into the rearview mirror.

For more analyses on dividend investing and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

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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 Straco Corporation.