Don’t rely solely on capital gains when investing in stocks. This puts you at the mercy of the irrationality of the stock market and increases your investment risk. This book teaches you how to select stocks that give you steady but growing dividend income. At the same time, you will learn how to protect your capital and minimize your loss when the stock price falls, by buying the share at a very attractive price (a significant discount to the intrinsic valuation). This book offers you the right answers to the questions in every dividend investor’s mind: Should the dividend investing strategy only be employed in the worst of times? Are all dividend stocks the same? Is dividend yield the sole criterion for picking dividend stocks? What is an attractive price to buy a stock for dividend income? When should I sell my dividend stocks?
In addition to answering the above questions, this book helps you to:
Get This Book To Build Your Wealth With The Right Dividend Stocks!
RANK BOOKS
An Income Generating Strategy To Stock Investing With Lower Risk
MARK LIN
• Evaluate and pick the right dividend stocks based on two major concepts of Dividend Safety and Capital Preservation • Assess the safety and sustainability of dividend payouts for dividend stocks • Calculate the reference stock prices for buying and selling of dividend stocks using the Perpetuity Dividend Discount Model and other valuation methods • Build, maintain and monitor a portfolio of dividend stocks to generate a steady flow of income
The DIY Approach to finding the best dividend stocks
• • • • •
SECRETS OF DIVIDEND INVESTORS
“The market can stay irrational longer than you can stay solvent.” — John Maynard Keynes
SECRETS OF DIVIDEND INVESTORS The DIY Approach To Finding The Best Dividend Stocks
Mark Lin
Published by
rank books www.rankbooks.com
First Published August 2011 Published and distributed by: Rank Books Blk 1002 Toa Payoh Ind Pk #07-1423 Singapore 319074 Tel: 65-62508180 Fax: 65-62506191 Website: www.rankbooks.com www.rankseminar.com Email: admin@rankbooks.com ISBN 978-981-08-9663-8 Cover Design and Typeset: Rank Books (www.rankbooks.com) Copyright Š Mark Lin 2011 All Rights Reserved. No part of this publication may be reproduced or copied in any form or by any means - graphic, electronic or mechanical, including photocopying, recording, taping or information retrieval systems - without written permission of Rank Books. Conditions of Sale: This book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, resold, hired out or otherwise circulated without the publisher’s prior consent in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser. While every reasonable care is taken to ensure the accuracy of information printed, no responsibility can be accepted for any loss or inconvenience caused by any error or omission. The ideas, suggestions, general principles, examples and other information presented here are for reference and educational purposes only. This book is not in anyway intended to give investment advice or recommendations to trade. The author or publisher shall have no liability for any loss or expense whatsoever relating to investment decisions made by the reader.
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About the author Mark holds a Bachelor in Accountancy Degree (First Class Honours) from Nanyang Technological University in Singapore. Having worked in private equity, equity research, and corporate finance advisory, he has had relevant exposure to analyzing and valuing both public and private companies across various sectors. He was formerly an Investment Analyst with a local brokerage covering the property sector in Singapore.
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PREFACE 2008: The Best of Times and The Worst of Times The idea for the book first came about on the eve of Christmas in 2008, the Straits Times Index (STI) had then fallen to 1,736. On the same Christmas Eve in 2007, the STI was at a high of 3,434. The STI went to record a low of 1,456 in March 2009. As the investment community shifted gears and called for a defensive strategy focusing on large cap dividend paying stocks during the period of uncertainty, a few questions came to my mind: 1) Should a dividend investing strategy be only employed in the worst of times? Or should it be an evergreen strategy applicable in both the best and worst of times? 2) Are all dividend stocks the same? Is dividend yield the sole criterion for picking dividend stocks?
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2011: Show Me The Money Fast forward to 2011, with the recent spate of negative news flow in the first half of the year, the investment community has brought the spotlight back on dividend stocks: • David Gerald, President/CEO of the Securities Investors Association (Singapore) (SIAS) released a statement to the media on the SIAS Website on 28 February 2011, urging more cash-rich listed firms to pay dividends to their shareholders, or provide a reason if they do not do so.
(Source: http://www.sias.org.sg)
• A Kim Eng Research report dated 24 March 2011 provided a list of defensive stocks with a track record of stable and high dividend payout ratio, which they termed as “tsunami-resistant stocks”. (Source:http://www.kimengresearch.com.sg/Download. aspx?rPID=1&rN=2403%20Sunny%20Side%20Up.pdf)
• In the recent first quarter of 2011 results, SingTel, SIA and SIA Engineering declared special dividends of 10 cents, 80 cents and 10 cents per share respectively
2012 & Beyond: Saying “I do” Dividend investors need to speak up and let their voices be heard. In line with SIAS’ statement ( see page v), shareholders need to understand their company’s dividend policy and voice out their concerns if the company does not pay out excess cash. Should the company choose not to pay out excess cash as dividends, the shareholders need to be aware of the company’s plans to deploy excess cash. Companies need to appreciate the value that dividend investors bring in the form of patient capital. Dividend investors are typically long term shareholders who do not trade as often and they bring stability to the company’s stock price. Companies should actively share wealth with shareholders by rewarding them with dividends. Now, let us recall the following questions which I raised at the start: 1) Should a dividend investing strategy be only employed in the worst of times? Or should it be an evergreen strategy applicable in both the best and worst of times? vi
2) Are all dividend stocks the same? Is dividend yield the sole criterion for picking dividend stocks? My answers are: i) Dividend stock investing is an evergreen strategy. Dividend stocks should be part of every investor’s stock portfolio. ii) No two dividend stocks are created equal. Investors need to equip themselves with the essential tools to build, maintain and monitor a portfolio of dividend stocks. So, how do you go about picking the right dividend stocks? I will show you the steps to evaluating and selecting the right dividend stocks based on two major concepts of Dividend Safety and Capital Preservation. Let us begin our learning journey.
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Contents CHAPTER 1: INTRODUCTION: Why DIY?
1
The Beginning of Stock Markets – A Vastly Different Era from Today!
1
Benjamin Graham – Was the Father of Value Investing also a Dividend Investor?
3
Does Buy and Hold Work?
4
All-season Investing and Best of Both Worlds
6
Capital Protected? Capital Guaranteed? Capital Recovery?
6
The Total Return Concept
7
CHAPTER 2: DIVIDEND BASICS I: THE COMPANY’S PERSPECTIVE
10
A Day in the Life of a Company
11
How to Assess a Stock that Pays Dividends?
13
Financing: The Cash INflows: Choice of Debt or Equity?
14
Financing: The Cash OUTflows: Dividends
15
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CHAPTER 3: DIVIDEND BASICS II: THE INVESTOR’S 16 PERSPECTIVE Why Should You Grow Your Money?
16
How to Grow Your Money?
17
Benchmark for Returns
18
CHAPTER 4: DIVIDEND BASICS III: FUNDAMENTAL TERMS AND CONCEPTS
20
Form of Dividends
20
Crucial Dates to Take Note for Dividend Investors
22
Terminology and Definitions – A Rose by Any Other Name
23
CHAPTER 5: DIVIDEND SAFETY I: CAN THE COMPANY PAY DIVIDENDS?
26
Credit Analysis: Will You Lend If You Were a Bank?
26
Qualitative Analysis: The 5Cs
27
Quantitative Credit Analysis: The Ratios & The Cash Flows
29
Simple Calculation of Free Cash Flow to Equity: The Ultimate Test
31
CHAPTER 6: DIVIDEND SAFETY II: WILL THE COMPANY PAY DIVIDENDS CONSISTENTLY? DIVIDEND SUSTAINABILITY
33
Dividend Payout Ratio
34
Dividend Payment Track Record
35
Earnings Risk
36
CHAPTER 7: DIVIDEND SAFETY III: IS THE DIVIDEND SUFFICIENT?
39
What’s the return? Is the Payback Enough?
39
Yield & Payback
39
Valuation
40
Perpetuity Dividend Discount Model
41
CHAPTER 8: CAPITAL PRESERVATION I: LOW RISK 44 How to identify stocks with Low Financial Risk
45
How to identify stocks with Low Business Risk
47
CHAPTER 9: CAPITAL PRESERVATION II: HIGH RETURNS
49
Identifying Stocks with High Returns on Investment Analysing the Growth Drivers of a Company
49 50 xi
CHAPTER 10: CAPITAL PRESERVATION III: UNDERVALUED STOCK
53
Prefer Dividend and Asset-Based Valuations over Earnings/DCF-Based Valuation
53
Adjusted Net Asset Value (ANAV) Approach
54
Example of using the ANAV Approach
56
CHAPTER 11: CAPITAL PRESERVATION IV: THE 2RV APPROACH
59
The 2RV Approach
60
Priortise!
60
Pick stocks with...
62
Table of Actions Using the 2RV Approach
63
CHAPTER 12: SINGAPORE POST LIMITED
64
Credit Analysis
65
Credit Information
66
Dividend Income
66
Dividend Payment Track Record
67
Dividend Risks
67
Capital Preservation
69
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CHAPTER 13: SINGAPORE PRESS HOLDINGS
70
Credit Analysis
71
Dividend Income
72
Dividend Payment Track Record
72
Dividend Risks
72
Capital Preservation
73
CHAPTER 14: RETAIL REITS: Frasers Centrepoint Trust
75
Introduction: Why Reits?
75
Industry Background
76
Company background
79
Credit Analysis
79
Credit Information
80
Dividend Income
80
Dividend Payment Track Record
81
Earnings Risk
82
Capital Preservation
82
Conclusion: What Has the Financial Crisis from 2008-2009 Taught Us about Reits?
83
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CHAPTER 15: OFFICE REITS: K-REIT ASIA
85
Introduction: Dividend policy risks for REITs
85
Industry Background
86
Company background
88
Credit Analysis
88
Credit Information
88
Dividend Income
89
Dividend Payment Track Record
90
Capital Preservation
91
Conclusion: Outlook for Reits
92
CHAPTER 16: PORTFOLIO MANAGEMENT
93
Building a Dividend Income (DIY) Portfolio
93
Managing a Dividend Income (DIY) Portfolio
95
Using the Total Return Concept to Manage Your Portfolio
96
CHAPTER 17: CLOSING THOUGHTS
64
Does Dividend Investing Work?
98
Summary
100
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Appendix I: FAQ on Equity Research
102
Appendix II: Additional Resources
112
Appendix III: Bibliography
114
Books
114
Academic Research
116
Websites
116
Company Presentation Material
117
Brokerage Research Reports
118
Market Research Reports
118
Newspapers
118
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CHAPTER 1
CHAPTER 1
INTRODUCTION: WHY DIY? “The market can stay irrational longer than you can stay solvent.”
~ John Maynard Keynes ~
The Beginning of Stock Markets – A Vastly Different Era from Today!
S
tock markets were initially created to allow companies to access capital, more specifically equity capital from a large number of institutional and retail investors. Individual and corporate investors will invest their monies in the company they choose in exchange for a share or ownership interest in the company. In return, the company will reward its shareholders with dividends (as and when companies decide to distribute the profits) and capital gains (as and when shareholders
SECRETS OF DIVIDEND INVESTORS choose to sell their stake in the company and where there are willing buyer and seller at a mutually agreeable transaction price). Investors saw the stock market as an opportunity to become minority owners of large successful companies, which were ordinarily out of their reach. On the contrary, today’s stock investors (or should we call them traders?) have an extremely short investment horizon ranging from a few minutes to a few months, focusing undue attention on share price movements – buying low and selling high (or buying high and selling higher). By definition, traders and investors used to be differentiated from each other by their investment horizon – the average time period for which they held their investments before selling. Today, the line between traders and investors has blurred. The investment horizon for many professional money managers (mutual funds or more commonly referred to as unit trusts in Singapore) is also getting shorter, largely due to immense pressure from the fund shareholders with respect to the quarterly reporting of portfolio performance through shareholder reports. For example, certain portfolio managers employ a strategy called
CHAPTER 1
‘window dressing’: they sell bad-performing stocks and buy good-performing ones near the end of the quarter or reporting period to “dress up” their portfolio. The advent of the Internet and the easy availability of financial information and news have been more of a bane than a boon for retail investors. More and more retail investors are trading on “news” (or even reacting to them blindly), without realizing that most of the information or “news” have usually been factored into the stock prices by the time it reaches the masses.
Benjamin Graham – Was the Father of Value Investing Also a Dividend Investor? Widely regarded as the father of value investing and the founder of security analysis, Benjamin Graham greatly valued dividends. One of Graham’s investment criteria for stocks included uninterrupted dividends for the last 20 years — that is the company had to pay a dividend every year for the past 20 years. Modern practitioners of value investing seem to have largely shifted their focus from buying dividend stocks to buying only undervalued stocks, regardless of the presence (or absence) of dividend payments.
SECRETS OF DIVIDEND INVESTORS
Does Buy and Hold Work? Should investors adopt the buy and hold strategy? I say, YES, if you buy and hold for good dividend stocks. But, for non-dividend paying stocks, I say, MAYBE! The concept of “buy and hold” (possibly forever) has largely been an item of contention among value investors today. The theory of “buy and hold” is premised on two major assumptions: (1) The company is a great company and continues to be great — there are no major changes in the value drivers and prospects of the company for the foreseeable future; and (2) The investor bought the stock at an attractive discount to its intrinsic valuation (or “margin of safety” as Benjamin Graham will call it). The biggest weakness of the buy and hold theory is that there is no explicit mention of exit – return of capital and upside beyond that to investors. So, what is the right strategy? Combining the idea of buy and hold and dividend investing makes more intuitive sense. An investor buys a consistent dividend paying stock and holds it for a period of time to
CHAPTER 1
receive dividend income. Once the dividend investor has recovered his capital (or at least a substantial part of it) through dividend income (it could take many years depending on the dividend yield), he could then choose to either to continue to hold the stock to receive dividends or sell the stock for capital gains. On the other hand, buying and holding a non-dividend paying stock for it to reach its “intrinsic valuation” could be a long fruitless wait, perpetuated by the fact that there are no dividends in between to tide the investor through. In the worst case scenario, the stock never reaches its “intrinsic” valuation or anywhere near, commonly referred to as a ‘value trap’.
(Intrinsic Value is centered on the premise that while the share price of a stock may fluctuate from day to day, influenced by news flow and sentiment; the stock price will eventually revert to a price called the intrinsic value, which is calculated based on the fundamentals of the stock using various valuation models, including the Discounted Cash Flow, the Dividend Discount Model etc.)
Here, the idea of a catalyst, a term commonly used
SECRETS OF DIVIDEND INVESTORS in equity research, is relevant. Stock prices frequently deviate from their intrinsic value, research analysts frequently identify catalysts, events that drives stock prices towards their intrinsic value, as part of their analyses.
All-Season Investing and Best of Both Worlds The fervent supporters of dividend investing have labeled it as an all-season investing approach. In bear markets, dividend income received will help to offset any paper or actual loss from falling share prices. In bull markets, investors enjoy the seemingly unbelievable combination of dividend income plus capital appreciation (share price gains). In that way, dividend paying stocks combine the best of both worlds: “safe bonds which pay a fixed periodic interest” and “risky stocks which promise unlimited returns and the possibility of total capital loss”.
Capital Protected? Capital Guaranteed? Capital Recovery? Before the Mini-Bonds saga, the market was full of marketing pitches talking about “return, return and
CHAPTER 1
more return” — they (including the financial advisers and investors) forgot about risk and capital. Indeed, it was a point of no return for many investors who have forsaken the enshrined concept of capital in favour of uncertain and volatile returns. On the other hand, there are patient dividend investors who have gotten their capital back at no cost, by accumulating the dividends through the years. Assuming a rather high dividend yield of 10%, the investor can expect to “recover” his capital in 10 years’ time. Beyond that point, anything earned from dividends is basically “upside” and future share price fluctuations will not result in a loss for the investor (he has already recouped his capital).
The Total Return Concept We return to the quote at the start of the chapter “The market can stay irrational longer than you can stay solvent.” Relying solely on capital gains puts investors at the mercy of the irrationality of the market and challenges the solvency of the investors. The author advocates a more conservative approach that dividend investors should focus on:
SECRETS OF DIVIDEND INVESTORS i) DIVIDEND SAFETY (see Chapters 5-7): steady but growing dividends and; ii) CAPITAL PRESERVATION (see Chapters 8-11): minimize any loss from falling share prices through buying the share at a significant discount to the intrinsic valuation (we call it the reference price in our book). For most investors, the calculation of returns on investment is solely based on capital gains or capital appreciation. However, a more rational approach is to take into account of the dividend income from the stock as well as the share price appreciation or loss which I termed it the “The Total Return Concept� in this book. A graphic model of this concept is shown in the following page.