It might be just my own anecdotal observations, but it seems that local investors are big dividend lovers – those pay-outs always seem to get a warm reception. But, every dividend’s definitely not created equal. How then, can we separate the wheat from the chaff? Here’s how – we look for the cash. Or more specifically, we look for a company’s cash flow as well as cash hoard.
Remember, Cash is King!
In the daily course of action for any business, it either generates or consumes cash in the end. If cash is generated, it’s first used to touch up on existing income-producing assets (generally known as capital expenditures). After which, any left-overs can be used to pay out dividends, stored up as a cash balance or used for acquisitions, among others.
That left-over cash, in investing terms, is known as Free Cash Flow, or FCF
And, as investors, we’ll like to know how much of each dollar of sales is converted into FCF. Generally, the higher theFCF/Sales ratio is, the better it would be for shareholders. And, ideally, it would not fluctuate wildly.
A quick scan of the Straits Times Index(SGX: ^STI) for the highest yielding companies (not including business trusts and REITs as they are slightly different entities) throws up three names as shown in the table below.
What’s wheat and what’s chaff? Let’s find out by starting with how these companies fared with their FCF/Sales ratio in the graph below. In the last five years, telecommunications operators Starhub and SingTel have consistently turned at least $0.17 of every dollar of sales into FCF. Compare that with the wildly erratic FCF/Sales ratio of aircraft maintenance and repair firm SIA Engineering, and it seems the two telcos have put a better act together in terms of generating cash.
But, that’s not all that is important to investors. The net-cash (net of debt, that is) found on a company’s balance sheet tells us how much dry powder it has to help it tide over difficult times.
On that count, SIA Engineering’s the only one with a meaningful figure, with net-cash representing 9.3% of its current share price. The telcos both have way more debt than cash: Starhub has a net-debt figure of S$290.2m while SingTel carries S$6.78b more in debt than cash.
How Much Are They Paying Out Again?
We know that Starhub’s shares have the highest dividend yield. But, do you know they’re also paying out almost everything they have in terms of earnings? This can be seen from its payout ratio, which is defined simply as dividends divided by its earnings.
A lower payout ratio gives a company more room to wiggle to protect those dividends should earnings be negatively impacted. Conversely, a higher payout ratio offers a smaller margin for error in sustaining those dividends if earnings decline.
The graph below shows the payout ratio of the three companies for their last completed financial years and SingTel comes out tops here by paying out the lowest amount of its earnings as dividends.
Foolish Bottom Line
Before you rush out thinking SingTel makes a good dividend share, pause for a moment. Looking at these numbers, two things spring to mind:
- It’s not easy finding a dividend share that ticks all the right boxes. But, that doesn’t mean we should be lax in our criteria. After all, we’re investing our own hard-earned money and we ought to be firm and disciplined.
- None of these figures tells us what a company’s going to do going forward. History can be a great teacher and offers us big clues about how a company might fare in the future. But, we can never be so sure. So, it definitely pays to think hard about a company’s future prospects instead of relying solely on historical figures.
SingTel has the highest average FCF/Sales ratio with the lowest payout ratio – that makes it seem like a good dividend share. But, can telcos afford the massive infrastructure spending for increased data-usage that consumers require? Can they sustain revenues in the face of pressure from mobile messaging-and-voice apps like Whatsapp?
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