Dividend Chaser on low PE and high dividend

(From Article)

To most investors, a high dividend yield and low PE ratio would be a good signal for value. But, there’s a difference between using the low valuations as a jump board for further research, as compared to a blind-purchase that’s superficially based on those metrics.

On first glance, Amtek Engineering’s(SGX: M1P) 9.6% dividend yield seems mouth-watering, especially when held up against the Straits Times Index’s (SGX: ^STI) yield of around 3%. Plus, its PE of 8.4, which is almost one third lower than the STI’s earnings multiple of 13, makes it seem like it’s a good bargain.

But, there is more than meets the eye with this manufacturer of precision-engineering parts.

Looking Underneath the Hood

Let’s take a look at the graph below showing the company’s quarterly earnings starting from the quarter that ended on Dec 2010. In the ten quarters since, Amtek’s quarterly profits have shrunk, almost in a linear fashion, from US$13.2m to US$4.15m.

In Amtek’s latest quarterly earnings release, management sees continued difficulties in macro-economic conditions which can impact upon the demand for their products. If the downward-trend in earnings continues, its low PE bargain-status might prove to be illusory.

That’s not all. Dividend yields are obtained by dividing a company’s full-year payout for its last completed financial year by its current share price. In the case of Amtek, that would be a dividend of 4.5 Singapore cents (for the financial year ended June 2012) and a share price of S$0.47, equating to a yield of 9.6%.

In the company’s ongoing financial year (started on June 2012 and ending on June 2013), it has so far only managed to pay out 1.3 Singapore cents. And, the omens don’t look good – Amtek’s dividends have shrunk from 5.5 Singapore cents for the financial year ended June 2011 to 4.5 cents.

There’s no telling what a likely dividend figure would be for the company’s remaining quarter. But, with smaller earnings in the upcoming quarter a distinct possibility, it’s not hard to imagine a much smaller full-year dividend pay-out for the ongoing financial year.

And, we should not forget that one contributor of a low PE and high dividend yield is a falling share price. On that count, Amtek shares have fallen by 23% in the past year even as the STI gained by 20%.

‘Comrades’ in Arms

There are a whole host of shares that have PEs much lower than the market’s as well as dividend yields that are higher. While there will be some that represents true bargains, there are others who will be pretenders to the bargain-throne.

For example, there’s Vard Holdings (SGX: MS7), a ship and vessel builder for the oil & gas industry with a dividend yield of 11% and a PE of 7.8 at a share price of $1.17. The company’s shares also face the triple whammy of declining earnings, shrinking dividends and a falling share price.

Of course, companies like Amtek and Vard Holdings can whip their businesses into shape and engineer a turnaround in fortunes. An investor should take note of the important factors concerning these companies to make an informed estimate of the probability of a material improvement in their business results.

Foolish Bottom-Line

A high dividend yield and low PE certainly looks attractive. But it pays to look deeper.