In learning how to invest in Singapore, you will often hear the words ‘dividend’ and ‘dividend yield’ being tossed around in analytical speak. However, what are these and how are they calculated.
Dividend is a payment from the company to its shareholders. This payment is often a percentage of the company’s earnings over the last financial year. As such, companies may at times propose to increase dividend payout if the company had a good year. When companies pay a dividend, it need not come in the form of cash. Companies can also issue shares of stock. This is also known as scrip dividend.
However, there may be times where dividend is not paid out of current year earnings. As shareholders get used to the dividends paid out by companies on a semi-annual or quarterly basis, they may have come to expect at least the same amount of dividends as last year. Failing which, they may sell the share and cause a large sell off in the market. With many senior management’s job performance measured in part by the performance of the company’s stock, management may become reluctant to reduce dividends even if the company’s performance miss market expectations.
For the budding investor, it is important to note that there are only few type of companies or investment vehicles that are able to issue a dividend. For companies, they would need to have strong mature cash flow generating business units that enable them to reward their shareholders. If the company is a start-up it will need to reinvest the cash into its business for growth. Hence it is very unlikely that start-ups can provide a dividend to shareholders. Apart from companies, there are also investment vehicles. Investment vehicles such as Real Estate Investment Trust, have to issue dividends by design. Given the long list of mature companies / investment vehicles, there are those who go by a high dividend investment strategy.
A high dividend strategy?
As mentioned earlier, there are those who believe in a high dividend strategy. Imagine buying into all the companies that pay out a high dividend. By making the maximisation of dividend yield as the sole criteria, one is able to create a portfolio that generates the most projected cash flow for the investee. To do this, an investor cannot just look at the absolute level of dividends that the company provide, but must also look at the share price. A stock providing $1000 in dividends is a lot more attractive at $2000 than it is at $200,000. As such it is important to look at the concept of dividend yield which is calculated as:
By using dividend yield formula, investors effectively normalise the effect of different share prices and is theoretically able to get maximum bang for the buck. Apart from the dividend yield, it is also important to know about the administrative details surrounding Ex Dividend Dates. This is because you do not want to buy into the security only to realise you do not qualify for the dividend that you thought was yours. That can cause a small dent in your portfolio returns.
When companies want to issue dividends, they will often announce it via SGX or on their company website. This will be subject to approval of its shareholders during the Annual General Meeting. If approved, the stock ticker will flash CD (cum dividend) and XD (ex-dividend). To be entitled to the dividend, the investor must buy when the stock is still flashing CD or one day before XD. After which, they will not get the dividend payout.
Is the strategy viable?
A high dividend strategy will only work if the stock price is either increasing or constant over the holding period. However, it can lead to heavy losses if price declines of the stock holding far exceeds the dividends that the investor receives. How can this be?
When stocks are bought for their high dividend yield, it is often assumed that prior year’s high dividend yield will always be the case going forward. However, in the event that the company’s financial performance falters due to unforeseen circumstances, such as the recent Covid 19 or simply due to a cyclical downturn, such high levels of dividend pay-out may no longer be possible. When such events occur, the company may come out to announce a cut in dividends. Such announcements can cause sharp declines in share price and affect the total return from your investment.
Even if companies maintain dividends, it can be difficult to do so as economic conditions get more challenging. This is because, management will keep having to find sources of cash for its annual dividend. It is important to note that such declines can happen to any company including well stablished mature companies. Examples of which include Sony, Nokia and Kodak. These companies used to be industry giants but have since lost their stellar market position as they have not been able to catch up with industry changes.
Hence, a high dividend strategy is only viable if the investor keep a watchful eye on the business to ensure that it is not going through economic decline. In other words, high dividends is icing on the cake but not the cake itself.