A £10,000 investment in RWS Holdings (LSE:RWS) generates £1,405 a year in passive income. But a 14% dividend yield is a sign the stock market thinks there might be trouble ahead.
Investing always comes with risks, but the firm maintained its interim dividend in its June update. So will investors who don’t buy the stock regret a huge missed opportunity?
What does RWS do?
RWS specialises in language translation. On the face of it, that’s the kind of business that might immediately come under threat from advances in artificial intelligence (AI). The firm however, has been alive to the rise of AI. And a core part of its business involves specialist translations for legal, financial, and drug trial documents.
Mistakes in these areas could result in huge liabilities for a company. So there’s arguably a big risk for a firm in using an automated service over one of RWS’s experts with specialist knowledge.
The firm’s also been working on its own AI product lineup. This includes a translation platform, a data set to train large language models, and offering AI translations with human oversight.
Why’s the stock down?
The firm’s had two major issues. The first is weak demand in its Regulated Industries division – especially in Life Sciences – and the second is pricing pressures in its Language Services unit.
In Regulated Industries, pressure on the pharmaceutical sector in the US is part of the reason for weak Life Sciences sales. But I do expect this to normalise over time.
The issue in Language Services is more concerning, in my view. Over the long term, the concern with RWS is that improvements in the likes of ChatGPT will cut into its pricing power. This might lead to customers going elsewhere. But even if it doesn’t, I think it’s likely to be a significant challenge for the company’s future growth and ability to offset rising costs over time.
What about the dividend?
With a 14% yield however, investors might take the view that RWS doesn’t really need to grow much to generate a good return over the long term. And I don’t disagree with that at all.
In its June update, the firm maintained its interim dividend of 2.45p a share. And management stated that this was a demonstration of their confidence in the business and its future prospects.
Investors should note however, that the recent difficulties RWS has been facing mean this isn’t fully covered by cash flows. And if this doesn’t change, cutting the dividend might be non-optional.
Over the last 10 years, the company’s returned significantly less than 50% of its free cash flows to investors. So even if things improve slightly, I think there’s still reason to be concerned.
Dividend stocks
RWS isn’t an ordinary translation firm – which would be extremely unattractive in an age of AI. Its focus on highly specialised industries and AI integration sets it apart from this type of business
Despite this, the competitive threat that comes from improvements in the likes of ChatGPT has to be taken seriously. I think there’s a real threat to the firm’s pricing power on the horizon.
A 14% dividend yield might go some way to offsetting this risk. But with this no longer covered by the company’s cash flows, I think investors can afford to consider letting this one go.
