Here’s 1 Share for Growing Dividends

Nitrile and rubber gloves maker Riverstone Holdings Limited  (SGX: AP4) would not be a share that would excite investors who are looking for high dividend yields.

At its current price of S$1.695, the company has a yield of just 1.5% thanks to its annual dividend of RM0.069 per share (approximately S$0.026) in 2014. 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 2.7% at the moment.

But while Riverstone’s yield might be tiny now, it may just be a share that can make income investors of all stripes smile by virtue of its potential in being able to distribute growing dividends over time.

The dividend sausage-factory

In general, there are a few things I like to find out about a company when I’m trying to assess its ability to pay out dividends that can rise steadily in the future:

  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. The higher the company’s free cash flow can be over time, the larger the potential for growing dividends.

  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 the resources to protect its dividends during the inevitable tough times that rolls along every now and then.

Pulling it all together

Here’re two charts that show how Riverstone has fared against the three criteria from 2006 to 2014 (a longer time-frame isn’t used because the company only got listed in November 2006):

Riverstone's dividends and free cash flow

Riverstone's balance sheet figures

Sources: S&P Capital IQ

As you can see from the charts, Riverstone has excelled in two areas over the time frame under study: 1) Its dividends have increased in each consecutive year and 2) its balance sheet has been like a fortress (there has been zero or minimal debt).

That being said, the company’s cash flow situation does seem a little worrying. But, there’s a good reason for the drastic drop in free cash flow in 2014.

In that year, that company had been spending heavily to ramp up its production capacity for future growth; to that point, Riverstone had reported an annual capacity of 4.2 billion gloves at end-2014, up 1.1 billion from end-2013. The company’s still busily expanding its facilities and it is expected that the firm will end 2015 with the ability to manufacture 5.2 billion gloves per year.

If the increase in the company’s capacity is met by growing demand, this may then result in larger streams of free cash flow in the future.

A Fool’s take

There are clearly things to like about Riverstone as a share with the potential for growing dividends. But, it’s worth noting that this look at the glove maker’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 and consider the odds that its business would grow in the future. A study of Riverstone’s financial track record 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 companies mentioned.