The dividend yield of a company tells us nothing about the sustainability of its dividends in the long run. A company that is yielding say, 4%, may or may not be able to sustain the 4% yield the following year, assuming there?s no change in the share price.
To find out if the dividend dished out by a company is sustainable, we have to look at its free cash flow and dividend payout ratio instead. By the word ?sustainable,? I mean that the company?s dividends can be paid from the cash generated from daily operations, and not from the accumulated…
The dividend yield of a company tells us nothing about the sustainability of its dividends in the long run. A company that is yielding say, 4%, may or may not be able to sustain the 4% yield the following year, assuming there’s no change in the share price.
To find out if the dividend dished out by a company is sustainable, we have to look at its free cash flow and dividend payout ratio instead. By the word “sustainable,” I mean that the company’s dividends can be paid from the cash generated from daily operations, and not from the accumulated cash balance over the years.
With these in mind, let’s find out if Singapore Exchange Limited’s (SGX: S68) dividends are sustainable. The firm’s shares closed at S$7.46 on 6 September 2017, and they have a dividend yield of 3.8%.
The table below shows a summary of some of the key figures from SGX’s past few financial years (its financial year ends on 30 June):
Source: Singapore Exchange Limited’s Annual Reports
From FY2013 to FY2017, SGX has been consistently paying out a total dividend of 28 cents per share.
It can be seen that, generally, the free cash flows produced over the years have been able to support the dividends paid.
The dividend payout ratio tells investors what percentage of a company’s earnings are paid out yearly as a dividend.
SGX’s has paid out more than 80% of its net profit as dividends over the years. This is in line with its dividend policy, which is as follows:
“For each financial year, SGX will pay as dividend an amount which is no less than 80% of the annual net profit after tax or 20 cents per share, whichever is higher.”
What this also means is that there’s a dividend floor of 20 cents per share. If basic earnings per share (EPS) drops to 25 cents or below, shareholders would still receive a 20 cents dividend.
For FY2017, basic EPS was at 31.7 cents. To put things into perspective, the basic EPS for FY2009 was 28.7 cents. It was in FY2009 when the Global Financial Crisis sent the stock market to its bottom, hugely impacting SGX’s business.
For the basic EPS of SGX to slump to below 25 cents, it must take an economic crisis worse than the Global Financial Crisis.
However, dividend policies are not cast in stone. If the EPS is constantly below 25 cents every year, and if SGX requires the money to grow its business without taking on debt, it might have to alter its dividend policy.
My view is that as long as the free cash flows produced support the dividends to be paid out and SGX’s business is not impacted by a financial crisis as severe as 2009’s, dividends from SGX would be sustainable.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of Singapore Exchange Limited. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.