This Share Has an Attractive Dividend Yield Of 5.5% – Are Its Dividends Safe?

A share with an attractive dividend yield may appear to be an enticing investing opportunity.

But, it’s important for investors to look beneath the hood with each high-yielding share to ensure that its business fundamentals are strong enough to help support the share’s dividend. Otherwise, a high-yielding share may end up being a mistake you’d have to pay for.

With that in mind, what should investors make of Vibrant Group Ltd (SGX: F01)?

At its current share price of S$0.101, the logistics, real estate, and financial services group has a tasty dividend yield of some 5.5% based on its dividend of 0.55 Singapore cents per share for FY2014 (financial year ended 30 April 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 just 2.6% at the moment.

Makings of a strong business

When it comes to looking for strong business fundamentals which can help support a firm’s future dividends, there are a few things I like to look into:

  1. 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 an ability to tide over tough times.

A tough comparison

Here’re two charts showing how Vibrant Group has fared against the three criteria over time:

Vibrant Group's dividends and free cash flow Vibrant Group's balance sheet figures

Sources: S&P Capital IQ

Over the 11 year period from FY2004 to FY2014, dividends paid out by Vibrant Group have more than quintupled – from 0.1 cents per share to 0.55 cents per share. But, it’s worth pointing out that firm’s dividends have been erratic; there were no dividends in FY2009.

Furthermore, Vibrant Group has had trouble generating positive free cash flow (it had negative free cash flow in eight of the 11 financial years under study) and had also seen the important financial metric decline consecutively over the past six completed-financial years.

Moving on the balance sheet, Vibrant Group has not fared too well here either: The firm has had a weak balance sheet that carried more debt than cash for the most part.

Investors might also want to note that the firm’s borrowings have increased at a rapid clip over the past few years. The trend has continued of late; Vibrant Group’s latest financials shows that it had S$276 million worth of borrowings as at end-January 2015, up from S$225 million at the end of FY2014.

A Fool’s take

Given what we’ve seen from Vibrant Group – the erratic dividends, negative free cash flows, and weakening balance sheet – it would appear that the firm does not have strong business fundamentals. Consequently, there’s a chance that the firm may not be able to sustain its current level of dividends.

That said, it must be noted that this look at Vibrant Group’s historical financials is certainly not a complete overview of the entire picture. Investors would still need to investigate the qualitative aspects of the firm’s business and consider if brighter days are ahead.

A study of Vibrant Group’s financial history is important and informative. But, more work 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.