Most investors want high return from investment with little risks. They want good return but shun risk and try hard to avoid risks most of the time. The behavior of risk averse in investing is a good thing, as preservation of our hard-earned money is more important than trying to make big, and incur unnecessary risks. Hence, many are attracted to the sale pitch of “Capital Protected Funds”, (risky) bond funds etc., which are poor investments which cap the upside potential of investors, with not much better downside protection than equity. Think about the structured products of the late 2000 during the US subprime housing crisis, CDS, CMS, CDS2, etc., when investors lost most of their capitals in those derivatives.
Fundamental investing in investing for high dividends is a much better alternative and inherently a low risk investing strategy suitable for most people.
Dr. Neoh Soon Kean, in his book “Stock Market Investment in Malaysia and Singapore” gave dividend as the only reason that drives the share price as shown in his statements as follow:
“THE VALUE OF A SHARE DEPENDS ON ITS FUTURE DIVIDENDS”
“THE VALUE OF A SHARE DEPENDS ON ITS FUTURE DIVIDENDS”
Note there is no mistake in the double sentence. It just shows the heavy emphasis of dividend in investing.
He said, share is just a form of investment. Except for special situations, the return that they can provide must bear some relationship to the alternative returns that investors can get, for example fixed deposit rate, return from rental in property investments, etc. The dividend yield (DY) investing in a share must bear some resemblance to the returns from alternative investments.
Why is dividend important
“A stock dividend is something tangible-it is not earnings projection; it is something solid, in hand. A stock dividend is a true return on the investment. Everything else is hope and speculation.” Richard Russell
Dividend is a real thing. Jaycorp’s share at RM1.49 now, and with 10 sen dividend a year, its dividend yield at 6.7%, is twice that of bank interest rate. You pocket it, use it for consumptions, or reinvest in the same or other dividend shares and in return, get more dividends.
During the bear market, Jaycorp share may go down to RM1.00, but you would not feel too scare as the dividend yield is 10%. In other words, it can provide a “floor” for share price when bear stampedes, and you won’t get too worried and still can sleep well:
When the market is too hot, dividend yield keeps us in close touch with the real world. You won’t buy XingQuan shares despite they have announced beautiful earnings, increased in earnings, and even good cash flows, and have heaps of cash in their balance sheet much higher than its share price, will you?
Finally, dividend yield prevents you from being side-tracked by events which have little or no real benefits to you as a shareholder, such as bonus issues, share splits, free warrants, property injections by major shareholders, merger and acquisition, high growth, and getting of big contracts which keep on losing money like before etc. like these ones:
http://klse.i3investor.com/blogs/kcchongnz/63777.jsp
What would have happened to your investment outcome if you have chased the bonus issues and shares split plus “free warrants” of Asia Media, free warrants from XingGuan, the numerous bonus issues of EAH, Instacom/Vivocom, etc. when these companies hardly pay any dividends.
Why not capital gain?
But why haven’t I talk about capital gain, which is the second part of the total return equation?
Total return = Dividend + Capital gain
Capital gain is of course important. But what logical reason you can give for the share price to go up? I know share price, especially those illiquid shares with very little free float in the market, can go up when someone “fries”, or manipulate it.
The share price will go up because of the growth in dividend. The management must manage the company well so that the company can pay growing dividends.
The dividend of Padini ten years ago was 1.4 sen in 2006 when it was trading at an adjusted price of about 35 sen. The dividend yield then was 4.0%. Its dividend has increased to 12 sen now and at RM3.71 at the close on 21st July 2017. The DY is still attractive at 3.2%, better than the FD in banks, when the share price has risen by more than 10 times.
Does buying high dividend stocks always work?
Not really. Table 1 below shows that if you have purchased HBGlobal with a dividend yield of 6.9% on 30/5/2012, you would have lost a whopping 84% as on 23rd July 2017, while the broad market has gone up by about 25% during the same period. AEGB, the former high flier Master Skill Education Group suffered the same fate with 80% loss. Even a seemingly good stock, JCY is not spared with a loss of 55% over the last 5 years, when it was at its high price of RM1.50 and giving 15 sen dividend then.
Table 1: High dividend stocks in 2012
The caveats on high dividend stock
High dividend investing strategy can very well be a winning strategy if the company has a stable business with consistent and proven cash earnings power that can grow over time. It may not be good for the company if there is inadequate normalized earnings and free cash flows. It is especially so if there is no excess cash in its balance sheet, and instead with significant debts.
This dividend payment is hence unsustainable as the company has to borrow or issues new shares in order to pay dividend. Paying too much dividend also negatively affect growth as less money is spent on capital expenses for the future growth of the company. A company with low return on reinvested capital is also unlikely to sustain high dividend payment.
When embarking on a high dividend investing strategy, it is better if you carry out the following checks:
- Dividend yields at least the same as the bank fixed interest rate, currently average about 3.0%.
- Dividend pay-out ratio should be less than a cut-off, say 65-85% so that there is money left and the business can still grow with the reinvestment for potential increase in future dividend.
- A business model that doesn’t require massive amounts of capital outlays relative to its earnings power.
- Reasonable expected growth rate in earnings at least matches the overall economy, say >4%, also for the potential growth in dividends in the future.
- Strong balance sheet for sustainability of dividend payment.
- High return of equity and capitals > 12% such that the dividend payment is not only sustainable, but grows from internally generated funds.
- Good free cash flows from where dividend is paid from internally generated funds
- Shareholder-friendly management dedicated to treating shareholders as owners
Taking the above into considerations, especially points 2, 3, 5, 6 and 7, the dividend payment is likely sustainable and growing as shown in figure 1 below for the growing dividend payment for Padini, which meets all the criteria above, over the years.
My experience in dividend investing strategy
I have used this dividend investing strategy for some stocks since end of year 2015. The portfolio of 5 stocks picked and written by me based on dividend investment strategy, and published in i3investor less than two year ago, as shown in the link below has gained 80% as on 23rd July 2017 as shown and summarized in Table 2 in the Appendix, while the broad market gained only 7.6% during the same period. The excess return is a whopping 73%.
http://klse.i3investor.com/blogs/kcchongnz/92727.jsp
There are two stocks, Padini and Scientex, gained more than 140%, followed by Perstima at +82%, in less than 2 years. The more interesting thing is there is not a single loser. The only underperformer in ECS ICT in share price was compensated by the high dividends shareholders receive every year.
The dividends for all the stocks were made up of about 10% return of the portfolio over the period.
This again shows the low risk feature of this high dividend yield investing strategy, specifically and in particular, the fundamental value investing.
Heads we win; Tails we don’t lose much.
Conclusions
Investing in high dividend stocks is my core investing strategy. It can be a winning strategy but it is not full proof strategy. However, it is a viable and low risk strategy if you can separate the chaff from the wheat, as you can see from my published portfolio here. Companies seldom cut their dividend, if they can afford to, as they do not want to send a negative signal to investors when their earnings drop a little temporary.
For those who are interested to get some good ideas of high dividend stocks to invest in for building long-term wealth, you may contact me at,
ckc14invest@gmail.com
You will learn about the fundamentals of investing along the way, and eventually able to scout for good high dividend stocks and evaluate yourselves to invest in using this incredible proven successful investing strategy.
Best of all, you would be able to avoid falling into the traps of the pumped and dumped syndicates which is clearly, very common nowadays.
Happy investing.
K C Chong
Appendix
http://klse.i3investor.com/blogs/kcchongnz/128386.jsp
Table 2: Return of dividend stocks as on 23rd July 2017
