Three Things You Should Check Before Buying Three-A Resources Berhad (KLSE:3A) For Its Dividend

Could Three-A Resources Berhad (KLSE:3A) be an attractive dividend share to own for the long haul? Investors are often drawn to strong companies with the idea of reinvesting the dividends. Unfortunately, it's common for investors to be enticed in by the seemingly attractive yield, and lose money when the company has to cut its dividend payments.

While Three-A Resources Berhad's 2.5% dividend yield is not the highest, we think its lengthy payment history is quite interesting. When buying stocks for their dividends, you should always run through the checks below, to see if the dividend looks sustainable.

Click the interactive chart for our full dividend analysis

Payout ratios

Dividends are usually paid out of company earnings. If a company is paying more than it earns, then the dividend might become unsustainable - hardly an ideal situation. So we need to form a view on if a company's dividend is sustainable, relative to its net profit after tax. In the last year, Three-A Resources Berhad paid out 34% of its profit as dividends. A medium payout ratio strikes a good balance between paying dividends, and keeping enough back to invest in the business. Besides, if reinvestment opportunities dry up, the company has room to increase the dividend.

We also measure dividends paid against a company's levered free cash flow, to see if enough cash was generated to cover the dividend. With a cash payout ratio of 180%, Three-A Resources Berhad's dividend payments are poorly covered by cash flow. Paying out such a high percentage of cash flow suggests that the dividend was funded from either cash at bank or by borrowing, neither of which is desirable over the long term. Three-A Resources Berhad paid out less in dividends than it reported in profits, but unfortunately it didn't generate enough free cash flow to cover the dividend. Cash is king, as they say, and were Three-A Resources Berhad to repeatedly pay dividends that aren't well covered by cashflow, we would consider this a warning sign.

With a strong net cash balance, Three-A Resources Berhad investors may not have much to worry about in the near term from a dividend perspective.

Remember, you can always get a snapshot of Three-A Resources Berhad's latest financial position, by checking our visualisation of its financial health.

Dividend Volatility

One of the major risks of relying on dividend income, is the potential for a company to struggle financially and cut its dividend. Not only is your income cut, but the value of your investment declines as well - nasty. For the purpose of this article, we only scrutinise the last decade of Three-A Resources Berhad's dividend payments. This dividend has been unstable, which we define as having been cut one or more times over this time. During the past 10-year period, the first annual payment was RM0.01 in 2010, compared to RM0.02 last year. This works out to be a compound annual growth rate (CAGR) of approximately 5.6% a year over that time. The dividends haven't grown at precisely 5.6% every year, but this is a useful way to average out the historical rate of growth.

Dividends have grown at a reasonable rate, but with at least one substantial cut in the payments, we're not certain this dividend stock would be ideal for someone intending to live on the income.

Dividend Growth Potential

Given that the dividend has been cut in the past, we need to check if earnings are growing and if that might lead to stronger dividends in the future. It's good to see Three-A Resources Berhad has been growing its earnings per share at 12% a year over the past five years. A company paying out less than a quarter of its earnings as dividends, and growing earnings at more than 10% per annum, looks to be right in the cusp of its growth phase. At the right price, we might be interested.

Conclusion

Dividend investors should always want to know if a) a company's dividends are affordable, b) if there is a track record of consistent payments, and c) if the dividend is capable of growing. Three-A Resources Berhad has a low payout ratio, which we like, although it paid out virtually all of its generated cash. We were also glad to see it growing earnings, but it was concerning to see the dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Three-A Resources Berhad out there.

Investors generally tend to favour companies with a consistent, stable dividend policy as opposed to those operating an irregular one. At the same time, there are other factors our readers should be conscious of before pouring capital into a stock. For example, we've picked out 1 warning sign for Three-A Resources Berhad that investors should know about before committing capital to this stock.

We have also put together a list of global stocks with a market capitalisation above $1bn and yielding more 3%.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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