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.