Wednesday 1 July 2015

Thoughts on Investing For Dividend Yields

In this blogpost, I hope to share my views on investing for dividend yields (something quite popular among other finance bloggers). I do not really subscribe to the belief that by looking at a basket of the highest dividend yield shares would yield superior results to other shares.

Is a good share one that pays out its earnings in dividends?
(Image source: http://zewt.blogspot.sg/2007/09/tax-free-dividends.html)

There are two goals in investing: Dividends or Capital Appreciation, both of which will provide your return on investment. A share paying out a 5% dividend and another whose price is growing at 5% a year is almost the same in my opinion, it is just whether the company decides to reinvest the money in itself or pay it out to its shareholders.

In my opinion, the important part which decides whether a company is better off paying out its dividends or reinvesting in itself would be the return on equity. If it is able to maintain or even grow a high return on equity (double-digit?) which is higher than my expected return on investment, I would be happy to let it keep its money for reinvestment in the business instead of paying it out in dividends. Likewise, a company that pays out a satisfactory dividend is also good.

There are stocks now that offer good dividend yields, look at Jardine Cycle & Carriage, which presents a good dividend yield for a company that is at the low end of their cycle (Read: Jardine C&C: Possible Opportunity for Dividends). These companies are good for people looking for a source of income which they can reinvest or use for their own expenses.

But there are also stocks that offer good value while paying almost no dividends. One of the stocks in this category that I'm watching is Ezion. Though is pays like 0.1 cent of dividend on a one cent share, it has a P/E ratio in the mid-single digits. While it is in the oil and gas sector which has declined considerably since its heyday, the fundamentals of the business still seem sound and even if it takes a hit to its profits, its currently low P/E ratio should be able to absorb it. I like it to not pay dividends for one key reason: It earns a high Return on Equity. around 20%. I would be hard-pressed to find another company that can return the same amount, or even if it decreased to say 10%, it's still better than the market return and the money that the company earns and reinvests in the business can also hopefully earn such a high return which would make the lack of dividends worthwhile.

Needless to say, good dividend yields and consistent payouts are good, but I don't think that we shouldn't only be looking out for shares with the highest dividend yields (these usually don't last very long anyway). We have to look at the underlying profits of the business and see if the dividends that it pays are sustainable or if the company is able to generate a satisfactory return on its equity, which can justify the retention of earnings. But I do not think that there should be a preference for a dividend-yielding stock unless maybe you're retired and looking for a passive income flow, but even then, good opportunities for capital appreciation should not be avoided.

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8 comments :

  1. IMO, ROA would be safer than ROE as the company may have a high leverage or debts.

    ReplyDelete
  2. Hi Nixonbhong,

    I don't usually use ROA, either ROIC or ROE. But when deciding the return that the company is earning on dividends I usually prefer to use ROE, with the debt to equity ratio usually taken into account when I purchase the stock.

    Thanks for the comment

    From,
    Just Some Thoughts

    ReplyDelete
  3. blue chips with a good track record give very certain/predictable returns on their dividends. example starhub has paid 20 cents a year for the last 6 years without fail. that makes its 5% return from dividends very solid

    however capital gains are usually less predictable, during a bear market even the best companies might see falling stock prices

    ReplyDelete
    Replies
    1. Hi Felix,

      I guess so but then again, bear markets are times when companies sell below their valuation and should be times that we are purchasing them. Also, stable blue chips that pay out stable dividends would also have their price affected during the bear market, so everything works out to be the same IMHO.

      From,
      Just Some Thoughts

      Delete
  4. Ezion seems to living on debts?

    ReplyDelete
    Replies
    1. Hi Lizardo,

      Yeah, guess so, thanks for pointing that out, but it seems to have its debt at a low interest rate. Its finance expenses were (surprisingly) only US$22m for over US$1b of debt in the form of notes and bank loans. And its also been able to use its debts to further grow its profits, which is good too, just need to be more wary as the oil and gas industry hits a rough patch.

      From,
      Just Some Thoughts

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  5. Is it possible to build a portfolio comprising of only REITs? I got 10 stocks in my portfolio now, of which 9 is REITs and 1 investment holding company. I thinking of adding another 2 REITs into it but not sure if it is overkill.

    ReplyDelete
    Replies
    1. Hi,

      It sounds like overkill to me, it would be a good idea to diversify into other types of investments like bonds and stocks, in companies in other industries as well, so your portfolio as a whole has less risk.

      Delete