The Motley Fool

Do You Own This Risky High-Yield Dividend Stock?

Electronic components distributor Serial Systems Ltd (SGX: S69) is one stock with an enticing yield right now. Based on its dividend of S$0.0085 per share for 2015 and its current stock price of S$0.132, it has a yield of some 6.4%.

For perspective, that’s a lot higher than the 3.5% yield that the SPDR STI ETF (SGX: ES3) has. The SPDR STI ETF is an exchange-traded fund that tracks the fundamentals of Singapore’s stock market barometer, the Straits Times Index (SGX: ^STI).

Although Serial Systems’ high yield may make it look like a good stock for dividends at first glance, a look beneath the hood actually reveals some important risks.

A trip back in time

Back in February 2015, I had taken a look at Serial System’s dividend and wrote an article on the company as it too carried a high yield of over 7% at that time. I looked at its financials from 2004 to 2014 and expressed my thought in the article that the company would be a yield trap, a stock with a high-yield but that would end up being a bad experience overall for shareholders.

There were a few reasons why I thought so. First, Serial Systems had not managed to produce free cash flow in a consistent manner; from 2004 to 2014, there were seven years in which it had generated negative free cash flow. Second, the company’s balance sheet was weak, with its debt levels being much higher than its cash hoard.

As it turns out, Serial Systems’ dividend in 2015 represented a 19% decline from the S$0.0105 per share dished out for 2014.

More pain ahead – possibly

There were some bright spots in Serial Systems’ results for 2015, such as the big jump in its free cash flow from US$2.6 million in 2014 to US$34.7 million. But, the company’s balance sheet had weakened yet further.

At end-2014, Serial Systems’ net-debt to equity ratio (where net-debt refers to total borrowings and capital leases net of cash and short-term investments) was 96.7%. This had climbed to 114% as of 31 December 2015.

That’s not what a healthy balance sheet looks like, in my opinion. It also adds risk to the company’s future payouts. Having a weak balance sheet places a company’s dividend at the mercy of its creditors as well as the vicissitudes of the business environment.

Moreover, in Serial Systems’ 2016 first-quarter results that were recently released, the company had clocked a loss of US$6.6 million, down significantly from the profit of US$3.1 million seen in the first-quarter of 2015. Its net-debt to equity ratio also remains over 100% and its operating cash flow in the quarter had fallen drastically from US$43.9 million a year ago to US$13.4 million.

A Fool’s take

Serial Systems has failed to tick the important boxes when it comes to the financial characteristics that lower-risk dividend stocks tend to be associated with, such as a strong balance sheet and a history of generating stable and growing free cash flow.

That’s something investors may want to keep in mind if they’re attracted to Serial Systems by its high yield.

But that said, what we’ve seen above about Serial Systems should not be taken as the final word on the investing merits of the company. A deeper study is required 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.