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Can This Company Sustain Its Tasty Dividend Yield Of 6.25%?

Credit: Ethan Lofton

Investors who are looking for shares with tasty dividend yields now might have come across Cheung Woh Technologies Ltd (SGX: C50).

At its current share price of S$0.24, the hard disk drive components manufacturer has a yield of 6.25% thanks to its annual dividend of S$0.015 per share for its fiscal year ended 28 February 2015 (FY2015).

This compares with the SPDR STI ETF’s (SGX: ES3) yield of just 2.76% at the moment; the SPDR STI ETF’s an exchange-traded fund which tracks Singapore’s market barometer, the Straits Times Index (SGX: ^STI).

But, the fact that Cheung Woh Technologies has a high yield now does not automatically mean it’d be a good dividend share. What’s more important here is the firm’s ability to sustain (or even grow) its current level of dividends in the future.

The foundations of a sustainable dividend

In general, there are a few things I like to dig into when I’m on the lookout for companies that can maintain or improve their payouts over time:

  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.

In contrast, 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.

How all the pieces fit

Here’re two charts which show how Cheung Woh Technologies has fared against the three criteria over its past 10 fiscal years from FY2005 to FY2015:

Cheung Woh Technologies' dividends and free cash flow

Cheung Woh Technologies' balance sheet figures

Source: S&P Capital IQ

We can see that the firm’s had a great track record in paying a dividend consistently in each year over the past decade – that’s commendable. Cheung Woh Technologies’ strong balance sheet (it has more cash than debt currently) also deserves a thumbs up.

But these being said, there are a number of areas of concern investors may want to note.

First, Cheung Woh Technologies has not been able to grow its dividends over time; its dividends have also been volatile in terms of the amount paid. Second, the firm has not been able to consistently generate free cash flow over the time frame under study and this raises questions about the viability of its dividends in the future.

A Fool’s take

There are things to like about Cheung Woh Technologies such as its strong balance sheet and nice run over the last decade in paying an annual dividend come rain or shine.

But, when other factors are also pulled into play, like the firm’s inability to generate free cash flow and its erratic payouts in each year, it would appear that there’s a chance that Cheung Woh Technologies may not be able to sustain its current level of dividends.

That said, it’s important to note that this look at Cheung Woh Technologies’ historical financial picture is certainly not a holistic overview of the entire situation. Investors should still dig into the qualitative aspects of the firm’s business and consider if brighter days are ahead.

A study of the company’s financial history can be 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.