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Is This Share A Good Dividend Play With Its 6.3% Yield?

Credit: Simon Cunningham

A high dividend yield is something which can attract investors to a share.

But, it’s worth noting that it can be dangerous to invest in a share just because it has a high yield as the yield figure tells us nothing about what’s important here – the reliability of the share’s dividend.

With these in mind, what should we make of Sin Heng Heavy Machinery Ltd (SGX: KF4)? At its current share price of S$0.158, the lifting solutions provider has an attractive yield of 6.3% thanks to its annual dividend of S$0.01 per share in the fiscal year ended 30 June 2014 (FY2014).

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

The makings of a strong dividend

There are a few things in general that I like to study when I’m trying to determine how reliable a company’s dividend may be:

  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 actual 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.

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.

Pulling it all together

The following are two charts showing how Sin Heng Heavy Machinery has stacked up against the three criteria from FY2010 to FY2014; a longer track record isn’t shown because the company was listed only in February 2010.

Chart 1 - Sin Heng Heavy Machinery's dividends and free cash flow

Chart 2 - Sin Heng Heavy Machinery's balance sheet figures

Source: S&P Capital IQ

Let’s have a few words about the company’s business performance.

Chart 1 shows that Sin Heng Heavy Machinery has been consistently paying a dividend ever since it got listed and that’s a commendable effort. That said, the firm’s dividends have fluctuated (falling from S$0.01 per share in FY2012 to S$0.008 in FY2013) and have not grown at all over the time frame under study. In addition, the firm has had trouble generating positive free cash flow.

A study of Sin Heng Heavy Machinery’s balance sheet in Chart 2 also shows that the company has lots of room to improve with regard to its financial health; to that point, the chart makes it clear that the company’s balance sheet has been weak with its level of borrowings coming in higher than its cash for the most part.

A Fool’s take

Given what we’ve seen with Sin Heng Heavy Machinery (its inability to grow its dividends; its lack of free cash flow; and its weak balance sheet), the firm does not seem to have reliable dividends and may thus not be a good dividend play.

That being said, it’s worth pointing out that this look at Sin Heng Heavy Machinery’s historical financials is not a holistic overview of the entire picture. Investors would still need to dig into the qualitative aspects of the company’s business and consider the future prospects of the firm.

A study of Sin Heng Heavy Machinery’s financial track record can be important and informative, but more work needs to be done beyond this 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.