Is This Stock With A High 5.0% Yield A Good Dividend Investment?

Investors who are searching for high-yielding stocks now may have come across GP Industries Ltd (SGX: G20). At its current price of S$0.675, the electronics and batteries maker has a tasty yield of 5.0% thanks to its annual dividend of S$0.034 per share in its fiscal year ended 31 March 2015 (FY2015).

For some perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund tracking the fundamentals of the Straits Times Index (SGX: ^STI) – has a yield of ‘just’ 3.4% at the moment.

But, having a high yield alone won’t make GP Industries a good dividend stock. What’s key here is the answer to the following question: What are the company’s chances of maintaining or raising its dividends in the future?

A strong yield’s building blocks

To find some clues to help with answering the aforementioned query, there are a few things in general about a company that I like to dig into:

  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.

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.

  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.

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.

GP Industries’ dividend: Yay or nay

The following chart below – Chart 1 – plots changes to GP Industries’ dividends and free cash flow over the its past 10 fiscal years from FY2005 to FY2015:

Chart 1 - GP Industries' total dividends and free cash flow (FCF) per share

Source: S&P Capital IQ

While GP Industries deserves a pat on the back for having dished out annual dividends without fail over the period under study, it’s not a healthy sign to see that its payouts have fluctuated wildly. To that point, GP Industries’ dividend had reached a low of S$0.0125 per share in FY2009, some 72% lower than the dividend of S$0.045 seen in FY2005.

The electronics maker has also had trouble with generating free cash flow, much less growing that important financial metric.

Chart 2 - GP Industries' balance sheet figures

Source: S&P Capital IQ

Chart 2 above shows how GP Industries’ balance sheet has changed from FY2005 to FY2015. There are some worrying signs: The company’s balance sheet has remained weak throughout the past decade with the level of borrowings exceeding that of cash.

Given what we’ve seen – the erratic dividends and free cash flow, and a balance sheet that’s weighed down by debt – it’d appear that GP Industries has some strong obstacles to overcome in trying to sustain or grow its dividends in the years ahead.

A Fool’s take

This investigation of GP Industries’ historical financials has highlighted some of the key risks that we should note with the firm’s future dividends.

But, it must be pointed out that investors would still need to study the qualitative aspects of the electronics and batteries maker’s business and consider if brighter days are ahead.

A look at GP Industries’ financial history 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 doesn't own shares in any companies mentioned.