Can This Share With A Tasty 5.5% Dividend Yield Sustain Its Dividends?

Credit: Ethan Lofton

When investing for dividends, it’s very important to not be blinded by the glow of a high dividend yield.

That’s because a share’s yield tells us nothing about what’s important here: The share’s ability to sustain or grow its dividend in the future.

Keeping this in mind, what should we make of TeleChoice International Ltd (SGX: T41)?

The communications solutions provider has a tasty dividend yield of 5.5% currently with its share price of S$0.29 and dividend of S$0.016 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 2.6% at the moment.

The anatomy of a sustainable dividend

For a share to have the ability to sustain its dividends, it needs to have strong business fundamentals. And when it comes to discerning the strength of a company’s fundamentals, there are a few things 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.

Keeping score

The two charts below show how TeleChoice has fared against the three criteria from 2005 to 2014:

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

Sources: S&P Capital IQ

Let’s start with the positives. Over the period under study, TeleChoice has managed to pay an annual dividend in each year. What’s more, the company has been able to do so while keeping a strong balance sheet that has consistently carried more cash than debt.

But, there are some significant negatives too. While TeleChoice has not missed an annual payout, it’s fairly obvious to note that its dividends have shrunk considerably over time. The firm has also had an erratic track record when it comes to generating free cash flow.

A Fool’s take

Despite the presence of consistent dividends and a strong balance sheet, TeleChoice’s inability to grow its payouts and free cash flow would suggest that there’s a chance that it may not be able to sustain its current level of dividends.

But, it’s worth pointing out that this study of TeleChoice’s historical financials is not a holistic overview of the entire picture. Investors should still pore over the qualitative aspects of the company’s business and consider its future prospects.

A look at TeleChoice’s financial history is important and informative. But, more work definitely needs to be done beyond that before any investing decision can be made.

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.