Saturday, 9 January 2016

The Dividend Trap

Looking at the sea of red suddenly gives me a lot of inspiration to write. In times of peace I was like in slumberland (for finance blogging). So while I am awake, I wanna shoot this very trendy investment term - DIVIDEND.

Is dividend yield most important when you make a stock selection?

Do you frequently look at dividend trackers?

Is your investing goal or objectives mostly revolving around dividends?

If all your answers are yes, then you might have fallen into the 'Dividend trap'.

Since Dividend yield = Dividend yield ($) *100/ Price of share ($), when there is rapid market melt-down what do you think happens? Dividend yield shoots up! Then you thought GOOD AH, BUY AH! Passive income ah!

If you scrutinize further, often those stocks which dividend yield shoots up like crazy (in beyond 10% range) are often companies which are most impacted by the ongoing economic changes or the weaker ones with say higher liabilities, weak earnings or poor growth. This is because other investors are dropping them like hot coals.

Some questions to ask are...

In times when the market recover, would their share prices recover as fast?
Are their business robust enough to weather the rough economies?
Are their high dividends sustainable?

Some businesses that pays good dividends are cyclical. Meaning that they do well when their industries do well and that explains the high dividend payout but once the spotlight is off and curtain's closed, the dividends would drop. Some examples are agriculture, properties and oil-rig companies.

Do note also that some companies gave inconsistent dividend payouts. For instance, on some years there are special dividends due to asset disposal or exceptionally good earning. So that one year does not represent the norm. Therefore,  I would advise looking at their 5 years dividend payout history, otherwise 10 years if it has been around for that long. You can view the accurate payouts via the SGX's website.

To sum it up, don't just happily filter stocks by checking on the highest dividend yield. Treat stock picking or stock analysis like watching 3D movies with surround sound - micro (stock indicators), micro (fundamental /moat) and macro (world economy), rather than looking at a snapshot which is 2D.

Looking at P/B, ROE, debt/price ratio or P/E might not even be good enough to justify a buy (as there are more factors to take into account), much less dividend yield. I am sure you vaguely remember something about 'not to drive by looking at the rear-view mirror'?

The dynamic factors changing ahead of you that affect these ratios are share prices (price momentum), future earnings, future liabilities due, assets revaluation etc.

At the end of the day, total capital return is what matter most and not just dividends collected.

Buy a good company at fair price or a fair company at good price?
You make your choice.

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