Is This Share’s Attractive 6.2% Dividend Yield Sustainable?

When it comes to investing for income, a mistake that investors often commit is to place too much focus on a share’s yield.

That’s a mistake because a share’s yield tells us nothing about what’s really important here – the sustainability of a share’s dividend.

Keeping these in mind, what should we make of Nera Telecommunications Ltd (SGX: N01)?

At its current price of S$0.645, the telecommunications equipment and payments solutions provider has an attractive yield of 6.2% (based on its dividend of S$0.04 per share for 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 just 2.7% at the moment.

The makings of a sustainable yield

When it comes to finding a sustainable dividend, there are few things which I like to dig into:

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

This is important because it gives investors insight into management’s commitment to reward investors as the business grows. As New York University finance professor Aswath Damodaran once said, “Dividends are like getting married; stock buybacks are like hooking up.”

  1. 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 issuance 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 an eye on a company’s free cash flow as it’s 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.

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

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

In contrast, a strong balance sheet that is flush with cash gives a company a valuable buffer against tough times.

Piecing the puzzle

Here’s a chart which shows how Nera Telecommunications has stacked up against the three criteria:

Nera Telecommunications' historical financials

Source: S&P Capital IQ

Over the years between 2007 and 2014, Nera Telecommunications had been paying a dividend consistently (the firm had missed a dividend payment in 2011, but it had specifically channeled an interim dividend of S$0.04 per share in 2012 to ‘make up’ for the short fall in the previous year). But, the firm has not been able to produce any sustained growth in its pay-outs.

Nera Telecommunications has also not been able to grow its free cash flow over the years; since 2012, the firm’s free cash flow has even come in lower than its dividends by a fairly wide margin.

Moving on to the balance sheet, this is where Nera Telecommunications shines: For the period under study, the company had carried plenty of cash on its balance sheet and had either zero or minimal borrowings.

But, it’s also worth pointing out that the firm’s balance sheet has weakened since 2011 as alluded to by the declining cash levels – the future shape of Nera Telecommunications’ balance sheet would be something to keep an eye on.

A Fool’s take

There are things to like about Nera Telecommunications’ finances, such as its history of consistently paying a dividend and its strong balance sheet. But, there’re also negatives to consider, such as the firm’s inability to grow its free cash flow and a balance sheet that has weakened over the past few years.

Pulling it all together, it would seem that there’s a chance that Nera Telecommunications’ current level of dividends may not be sustainable.

But that said, it’s worth pointing out that this look at Nera Telecommunications’ historical financials is certainly not a holistic overview of the entire picture. To arrive at a better conclusion on Nera Telecommunications’ investing merits, investors would still have to study the qualitative aspects of the firm’s business and consider if better days are ahead.

An understanding of Nera Telecommunications’ 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.

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 doesn't own shares in any company mentioned.