Can This Share With An Attractive 6.4% Dividend Yield Sustain Its Dividends?

A share with a high dividend yield may make for a great investment.

But, we should also be careful that we’re not blinded by the glow of a high yield when making an investing decision. That’s because a share’s yield tells us nothing about what’s really important here: The share’s ability to sustain or grow its dividend.

With that, what should investors make of Tai Sin Electric Ltd (SGX: 500)?

At its current price of $0.35, the cables and wires manufacturer carries an attractive dividend yield of 6.4% based on its dividend of 2.25 Singapore cents per share for the fiscal year ended 30 June 2014 (FY2014).

Comparatively, 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 ingredients for a sustainable yield

When it comes to looking for sustainable dividends, there are a few things about a company that I like to dig into:

  1. The 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. The 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 come from a few sources. A company can 1) take on debt, 2) issue new shares, 3) sell its assets, and/or 4) generate cash from its 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.

Having a weak balance sheet that’s laden with debt puts a company’s dividends at risk of being reduced or removed – either due to pressures from creditors or from a simple lack of cash – even at the slightest hiccup in the fortunes of the firm’s business.

In contrast, a strong balance sheet that is flush with cash gives a company the ability to tide over tough times.

Putting the pieces together

Here’re two charts showing how Tai Sin has fared against the three criteria over the past decade:

Tai Sin's dividends and free cash flow Tai Sin's balance sheet figures

Sources: S&P Capital IQ

For the timeframe under study, Tai Sin has done an admirable job of growing its dividends from 0.6 cents per share in FY2004 to 2.25 cents per share in FY2014.

But, the company’s track record in producing free cash flow has been spotty; there’s no sign of consistent growth and the financial metric had also dipped into negative territory twice between FY2004 and FY2014.

Cash levels at Tai Sin have also been much lower than debt for most of the decade we’re observing – that’s a sign of a weak balance sheet. The situation might be changing for the better given the sharp fall in borrowings in FY2014, but it remains to be seen if the improvement will be sustained.

A Fool’s take

There are things to like about Tai Sin’s finances (such as its solid track record in delivering higher dividends over the years), but there are also negatives to consider (like a weak balance sheet and the inability to generate consistent free cash flows).

On balance, it would appear that there’s a chance that Tai Sin may not be able to sustain its current level of dividends.

That being said, it’s important to note that this look at Tai Sin’s historical financials is certainly not a holistic overview of the entire picture. Investors should still consider the qualitative aspects of the firm’s business and consider if better days are ahead.

A study of Tai Sin’s financial history can be important and informative, but more work needs to be done beyond that before any investing decision can be reached.

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.