Here’s Why This Share May Be a Great Dividend Play

When it comes to finding a great dividend share, a focus on searching for a solid business is far more important than myopically obsessing over a high yield.

But, I guess no one would really complain if a share does sport both elements of having solid business fundamentals and a high yield. That is what investors may be getting with vehicle testing and inspection outfit Vicom Limited (SGX: V01).

At its current share price of S$6.55, Vicom has a tasty yield of 4.1% based on its dividend of S$0.27 per share for 2014.

In contrast, 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 2.7% at the moment.

What makes a strong yield

There are a few things I like to observe about a company’s business fundamentals when I’m looking for a great dividend share:

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

This criterion’s importance lies in the insight it can give investors about management’s commitment to reward shareholders as the business grows.

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

Ultimately, a company pays its dividends with the cash it has and 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.

  1. 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 better ability to tide over tough times and emerge relatively unscathed.

Putting it all into context

The chart below shows how Vicom has fared against the three criteria mentioned above for the period spanning 2004 to 2014:

Vicom' historical financials

Source: S&P Capital IQ

For the timeframe under study, Vicom has seen both its dividends and free cash flow exhibit an unmistakable upward climb. In addition, the firm’s free cash flow has also been consistently higher than that of its dividends.

The chart also makes the strength of Vicom’s balance sheet obvious – the firm’s cash levels have been growing significantly over the years and it has remained debt-free since 2005.

A Fool’s take

Given Vicom’s market-beating dividend yield and solid business fundamentals (a fortress-like balance sheet as well as growing dividends and free cash flow), the company may well be a great dividend play.

But that said, it’s important for investors to note that this look at the firm’s historical financials is certainly not a complete view of the overall picture. For a better conclusion on Vicom’s investing merits, investors would still have to study the qualitative aspects of the firm’s business to determine if its great business performance thus far can continue in the future.

A study of Vicom’s history is important and can give us some context to understand its future. But, we should never invest by looking purely 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 owns shares in Vicom.