The Motley Fool

If You Are Investing For Dividends, This Is 1 Thing You Should Look At

Offshore support vessels builder Nam Cheong Ltd (SGX: N4E) has just announced its fiscal fourth-quarter earnings this morning. Just prior to this earnings release, the company would likely have popped up on the screens of investors who are out looking for high-yielding stocks.

That’s because the company had a massive historical dividend yield of 15% based on 1) its closing share price of S$0.097 yesterday and 2) its annual dividend of S$0.015 per share for 2014. For perspective, the SPDR STI ETF (SGX: ES3) – an exchange-traded fund that mimics the fundamentals of Singapore’s market barometer, the Straits Times Index (SGX: ^STI) – has a yield of just 3.8% at the moment.

But sadly, in Nam Cheong’s latest earnings release, the company had removed its dividend completely. With that, the fat 15% yield has become zero – and therein lies the danger of placing a huge emphasis on a share’s historical dividend yield when making an investing decision.

This raises the question: What should income investors look out for then? One would be the balance sheet of a company. More specifically, it’s to look at how strong or weak the balance sheet is. It’s not the only thing investors should be mindful of, but it is a very crucial aspect of dividend investing, in my view.

If we compare certain figures from Nam Cheong’s balance sheet at end-2014 and end-2015 – as shown in the table below – we can see how its net-debt position (total borrowings minus total cash) and net-debt to equity ratio had both increased markedly. The company’s balance sheet was already weak in 2014, but it had become even weaker by the end of 2015.

Nam Cheong balance sheet numbers
Source: Nam Cheong’s earnings release

With the downturn in the oil & gas sector (the price of oil has declined drastically from over US$100 per barrel in mid-2014 to around US$30 today) having hurt Nam Cheong’s business badly, it’s easy – and logical, in my view – to think that the condition of the company’s balance sheet was one of the factors that were in the minds of the management team when they made the decision to stop the dividend.

There are other cases of companies slashing or removing their dividends in order to protect their weak balance sheets. Australia-listed mining giant BHP Billiton Limited is a great example.

According to my Australian colleague Tom Richardson, the company had made a comment back in November 2015 that its priority would be its balance sheet, not its dividends, after a fall in commodity prices had pummeled the company’s business. Based on its balance sheet figures as of 30 June 2015 (the latest available back then in November), BHP Billton had a weak balance sheet with US$31.2 billion in total borrowings but just US$6.75 billion in cash and equivalents.

Turns out, the company had announced its latest results earlier this week and ended up slashing its dividends by nearly 75%.

A Fool’s take

A strong balance sheet – one that isn’t heavily saddled with debt – gives a company higher odds of protecting its dividends even during times when its business environment becomes challenging. A weak balance sheet, on the other hand, reduces those odds.

If you’re an investor searching for dividend stocks, the strength of a company’s balance sheet is an important thing that you may want to look at.

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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.