Is This Share – With A 7.8% Dividend Yield – A Good Dividend Stock?

Credit: Simon Cunningham

A high dividend yield would always be welcome.

But, good dividend stocks need not necessarily have a yield that’s high right now – what’s more important is for the share to have strong business fundamentals as that can help drive its payouts higher in the future.

With that, what might we make of CDW Holding Limited (SGX: D38)?

The electronics components maker has a very attractive dividend yield of 7.8% at the moment with its share price of S$0.205 and dividend of US$0.012 per share (roughly S$0.0159 per share) in 2014.

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

Building blocks for strong fundamentals

When I’m out looking for strong business fundamentals, there’re 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 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.

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.

Pulling the threads together

Here are two charts which show how CDW has fared against the three criteria from 2005 to 2014:

CDW's balance sheet figures CDW's dividends and free cash flow

Sources: S&P Capital IQ

There are a number of things to like about CDW’s financials. As the charts show, the firm has been consistently paying a dividend over the period under study. In addition, its balance sheet has also been really strong with cash coming in higher than debt all these while.

But, there are also issues that investors might want to note. Despite never having missed an annual dividend over the past nine years, CDW’s payouts have been erratic. What’s more, the firm has had trouble generating positive free cash flow (2007 and 2013 had negative free cash flows) over the years; the important financial metric has also not shown any clear signs of growth.

A Fool’s take

Given what we’ve seen – the volatile dividends and free cash flow – it appears that there’s a chance that CDW may not be able to sustain its current level of dividends. It thus follows that CDW may not be a good dividend stock.

That being said, it’s important to note that this study of CDW’s historical financials is not a holistic view of the overall situation. Investors should still pore over the qualitative aspects of the company’s business and consider its future prospects.

A look at CDW’s financial history can be important and informative. But, more work definitely 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.