Would This Share With A 6.3% Yield Be A Safe Bet For Consistent Dividends?

Investors who are out hunting for shares with attractive dividend yields right now might have come across electronic components and consumer electronics distributor Karin Technology Holdings Ltd (SGX: K29).

At its share price of S$0.33 at the moment, the firm has a high yield of 6.3% thanks to its annual dividend of HK$0.13 per share (around 2.09 Singapore cents) in the financial year ended 30 June 2014 (FY2014).

In contrast, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking Singapore’s market barometer the Straits Times Index (SGX: ^STI) – has a yield of just 2.65% currently.

But while Karin Technology may have an attractive-looking yield, that alone can tell us nothing about what really counts – the company’s ability to pay-out consistent (or perhaps, even growing) dividends.

The makings of a strong yield

And to gain a better handle on that, 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 can give us important clues 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 actual cash flow from operations that remains 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.

On the other hand, a strong balance sheet that is flush with cash gives a company an ability to tide over the inevitable tough times that rolls along every now and then.

Failing in some respects

Here’re two charts which show how Karin Technology has fared against the three criteria for the period stretching from FY2005 to FY2014:

Karin Technology's dividends and free cash flow

Karin Technology's balance sheet figures

Sources: S&P Capital IQ

Let’s have some quick words on Karin Technology based on what we’ve seen.

Over the period under study, the company’s dividends have declined from time to time, but they’ve also displayed an unmistakable upward climb – that’s something to like.

But, there are also other important areas of concern. For instance, the firm has had trouble with being able to consistently generate positive free cash flow.

Meanwhile, Karin Technology’s balance sheet has also been weak for the most part as alluded to by the number of years in which the firm had carried more debt than cash. It’s worth noting too that the firm’s balance sheet has steadily deteriorated over the past few years. For some perspective, Karin Technology ended FY2011 with HK$74.7 million in cash and HK$24 million in borrowings; by end-FY2014, debt had ballooned to HK$170 million while cash had grown to only HK$94.6 million.

With that, investors might want to keep a close watch on the future shape of Karin Technology’s balance sheet.

A Fool’s take

Despite Karin Technology’s noteworthy track record in growing its dividend since its listing on March 2005, there’s a chance that the firm would not be a safe bet for steady dividends given its erratic free cash flow and weakening balance sheet.

That being said, it should be pointed out that this look at Karin Technology’s historical financials is not a holistic overview of the entire picture. Investors must still dig into the qualitative aspects of the company’s business and figure out if better days are ahead.

A study of Karin Technology’s financial history can provide us with important and informative context, 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.