Tuesday, October 6, 2015

Dividend Investing - Revisited

I would like to draw a reference post by GV which I thought he did really well in explaining the truth about dividend investing which many had overlooked.
Readers of this blog would know that I am a proponent of cashflow investing which is a subset of dividend investing if you like to see it that way. The main difference between dividend and cashflow investing is that the former can pay out dividends through the cash they burn while the latter pays out dividends through their operating cashflow which can sustain for as long as the company continue their service.
Let me explain the accounting terms behind this idea.
When a company pays out a dividend to shareholders, the cash portion is usually reduced by the same amount being paid. In fact, investors should know that dividend payment is part of a cashflow from financing activities under IAS 7 which will decrease the amount of cash retained in the books. Since retained earnings are reduced, the NAV of the company would decrease by the same amount. This explains why the moment the company goes ex-dividend, the share price would usually fall by the same amount of dividends paid in the short term. This is the bulk of what GV was explaining in his post but in a less technical terms so that beginners would understand.
So far, we've only been talking about the theory, which will unfortunately not always happen to be the case in practical and real life scenario. Sometimes, we may even see a company share price increase the moment they went ex-dividend. The reason for this is simple. People are bullish and are driving up the price by going long on the company. This is the psychological portion of investing that we may never truly understand unless you are an expert in understanding human behaviour.
Going back to what I have discussed earlier, this is precisely why I enjoy cashflow investing so much because for as long as the company is able to sustain its dividend payout through their operating cashflow earnings, you will always have buyers that will come in and drive the share price up eventually.
Contrast this with a company that backs itself up with a low dividend payout because it has to preserve cash to grow the company. The latter has to depend very much on the growth story of the business which most of the time has been priced into the share price. Companies such as Raffles Medical Group, Sarine, Osim and Super came to mind. The moment these growth stories slow down, the share price would plunge right down to what gravity would do to the company. This is somewhat different from investing in companies such as properties and banks because the latter would usually be valued at mark to market, which makes the valuation more relevant to their book value than earnings.
Dividend investing is not a bad strategy, but I think it is important for investors to understand the concept of cashflow investing because that's where the thin line will draw between a successful and average investors.


  1. Hi B,

    I think when we talk abut super, osim etc, we need to understand that different classification of companies command different valuation which is correlated to the risk-reward profile.

    It is a concept by Peterlynch

    When growth companies like OSIM and Super continue to grow, it is a grower, and it rightly should command more prenium in terms of PE, if a company is expected to grow 20% for 5 years, the PE will look super cheap in 5 years time if price remain the same, hence the seemingly high valuation to account for the growth.

    It is not so much that they are overvaluated but how long they can sustain this growth if you analysis that is important. IF OSIM/ST continue to grow at 20% for next decade, your 20 plus PE is a steal at current price.

    It is those that get caught at the end of the musical chair that get burns, also if a company continue to grow and pay a fix payout according to earnings, you might be getting a double yield for a blue chip (like CW)

    For the great rewards, potential yield expansion as well as capital gains, come great risk, just like when Diary farm is being re-rated as a slower grower or stalwart. Unless you believe the slow down in the earnigs is temporary, otherwise market is unlikely to give it grower valuation anymore.

    It is better to pick a stalwart with potential to become a slow grower if one is interested in income investng, than picking on growers hopring for yield expansion.

    1. Hi SI

      No I totally agree with your take on the growth companies. Assuming they can grow continuously at a 20% year on year for the next 10 years, a PER of 30x would probably still be a steal. Most of the time, the problem becomes when will it stop and it has to slow down someday.

      So you are right, whoever is late to the game can kiss their investment goodbye and I probably am weak at forecasting this. I'd prefer a much slower growth with predictability.

  2. Hi guys,

    I think ultimately it still boils down to who can make the better use of the dividends if not given to shareholders. If they have no better use of the earnings, like what SI mentioned in the matured industries, then giving out to the shareholders for them to grow it themselves is probably a better idea. If it's a fast growing company, where they have shown themselves to be astute investors of their earnings, then it's better not to give out to shareholders. Between these two extremes, we can always walk the moderate path. That's where the dividend payout ratio comes in.

    I was quite infatuated with the idea of capital growth only model in the past. Never believed in dividends. But I realised I lack the competency to sieve out the growers from the wannabes, and hence dividend giving company will ensure I get some compensation while waiting for the expectant capital growth. I think this is better. You get paid to wait for bigger rewards, rather than the promise of a huge reward at the end of the day in an uncertain world.

    From giraffe's post, we know one thing for sure. People don't read the post - they just read the troll-baiting headlines and interpret the rest of the article from there. But then again, we're dealing with a troll-baiting headlines, so what else can we expect but trolls? lol

    It's the kind of attention I'll rather than get. So many eyeballs, but the ire shrinks my balls.

    1. Hi LP

      My sentiments like you. Growth industries need a lot of patience and right timing entrance so perhaps it is one thing that is rather difficult to predict for me too. For dividend stocks, I'd rather get paid and probably taking it in the view of lowering my average costs so in any case even if I get it wrong, i'll get some consolations. lol

  3. Hey B

    Thanks for referencing to my post, I have made some adjustment on the part where explaining about the cash flow.

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  5. Hi B,

    I have just presented an alternative view point in my blogpost with regards to dividends as passive income - that in essence, when considered properly as part-owners of a business, the investor should not be overly concerned about the CD/XD effect and that dividends are indeed passive income to the owners of the business.

    Appreciate your view point on this. Thanks very much :)

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