Sometimes, you’d get stocks in the market that offer you a high yield with stable but stagnant dividends. At times, you’d get stocks that carry a miserly dividend yield but yet have the potential to grow its dividends in the future. And then there are occasions when you get to have the best of both worlds – a stock that offers both a high yield as well as the possibility of a growing dividend. That’s what investors might be getting with vehicle inspection and testing outfit Vicom Limited (SGX: V01) currently. At its present price of S$6.22, Vicom has a…
Sometimes, you’d get stocks in the market that offer you a high yield with stable but stagnant dividends. At times, you’d get stocks that carry a miserly dividend yield but yet have the potential to grow its dividends in the future.
And then there are occasions when you get to have the best of both worlds – a stock that offers both a high yield as well as the possibility of a growing dividend. That’s what investors might be getting with vehicle inspection and testing outfit Vicom Limited (SGX: V01) currently.
At its present price of S$6.22, Vicom has a tasty yield of 4.3% thanks to its annual dividend of S$0.27 per share in 2014. For some perspective, 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 2.7% at the moment.
With that, let’s see why Vicom has the potential to hike its payouts in the future and reward shareholders with a growing stream of income.
Let’s cook us some growing dividends
In general, there are a few things about a company’s fundamentals that I like to dig into when I’m trying to assess its ability to sustain or raise its payouts in the years ahead:
- 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.
- The company’s ability to grow its free cash flow over time and generate it in excess of the dividends paid.
Dividends are ultimately paid using the cash that a company has and that can come 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.
- 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.
In addition, it enables the firm to go on the offensive during a downturn and reinvest for growth even as its financially weaker competitors have to batten down the hatches; this plants the seeds for potentially higher dividends in the future.
Here are two charts showing how Vicom has fared against the three criteria over the past 10 years from 2004 to 2014:
Source: S&P Capital IQ
What they show is that Vicom has aced it. Over the past decade under study, the firm has seen both its dividends and free cash flow make unmistakable upward climbs. Meanwhile, Vicom’s free cash flow has also been comfortably higher than its dividends for the most part. Then, there’s also Vicom’s balance sheet being like a fortress with there being zero debt since 2005.
These traits help increase the odds that Vicom may be able to dish out higher dividends in the future over the years.
A Fool’s take
Given what we’ve seen, Vicom does seem like a share that gives income investors the best of both worlds – a high yield and the potential for growing dividends. But, there are still important risks to note.
Here’s one for instance: In 2011, the last year when Vicom reported segmental results, its vehicle inspection business had accounted for nearly two-thirds of total operating profit. With an ongoing slowdown in the overall vehicle population growth in Singapore (see table below), this could put a cap on Vicom’s future ability to grow.
Source: Land Transport Authority
Investors would need to carefully weigh the risks and rewards with Vicom. A study of the company’s financial track record – like what we’ve done here – can be important and informative, but more work needs to be done beyond this before any investing decision can be made.
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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 owns shares in Vicom.