Intelligent Investing
Finding a Good Dividend Stock
For more writeup, read them here
Two ways stock market can increase your wealth is through capital appreciation & dividend. And many investors rely on dividend as their source of income.
But finding a stock that can consistently pay you dividend every year and increase it yoy isn't that straight forward. There are a few pointers to guide you when selecting a good dividend stock.
1. Track record
The historical payout of a stock can tell you a lot about the reliability of the dividend. A stock that has been consistently paying dividend for the past 10 years is better than ones that pays in good years and stop it during bad years.
2. Payout ratio
Most Bursa listed companies have a payout ratio of 20-40% of their total yearly earnings. So if earning per share is $1 for the year, you are looking at $0.20-0.40 dividend per share. However if you notice a company has a payout ratio of over 70% of their earnings, you have to be careful and ask is that sustainable? Because not many business can payout so much without affecting their business, which brings us to point 3.
3. Look at the business
Companies use the money they earn every year and allocate them carefully to either reinvest into the business, pay off debts, pay dividend or buyback shares. So a company's ability to pay dividend is entirely dependent on how much the company earns and how capital intensive the business is.
Example. You notice Magnum and Y&G both gives you a dividend yield of around 8% so you are not sure which one is better. Maybe you might prefer Y&G because the share price has gone up by 20+% while Magnum has gone down in 2015.
Let's think. Magnum is mainly involve in gaming, 4D. It is a business that do not need to reinvest a lot. Maybe spent some on advertising, rent & open a shop, hire ticket agents that's it. That's why they can pay out a large chunk of their earnings to shareholders. On the other hand Y&G is a property developer. The capital intensity is higher than Magnum. Y&G needs to keep using majority of their earnings to buy land for development. More reinvestment = less dividend.
This doesn't mean you can't buy capital intensive stocks like plantation, steel or property. It's just that preferably you want business that doesn't need to invest so much.
4. Business that generate good ROE
ROE is the return a business make using the capital they have. Similar to how your savings account give you interest. Generally you will prefer a business than can generate >15% of ROE. High ROE and long consistency normally means dividend will grow over time.
5. Don't jump around
It is tempting to jump around stocks that offer the highest dividend yield. But normally staying with the same stock can give you a greater reward.
Example. Scientex was selling at $3.20 in 2013 with a dividend yield of 4.6%. Reasonable dividend, not too high or too low. But by 2015 the dividend yield would have increase to 6.8% base on your original investment. 47% growth in 3 years. Would it reach 10% in the next 5 years? Very likely. And we are not including the capital appreciation that the price is sitting at $10.50.
Picking a good dividend stock is the first half. Sit there and let it compound is the second half.
6. Buy it cheap
This is always the cornerstone of successful investing. Only when it is cheap, not because the dividend is high. But normally both goes hand in hand. A high dividend yield normally indicate a stock is cheap. But there are always exception.
Another reason to buy cheap is that you have limited downside and you will have a higher chance of being rewarded for an increase in dividend and share price.
Example. Focus Lumber was selling at $1.40 in early 2015. Based on 2014 dividend, yield is around 6%, a decent yield. However it looks cheap in every way. From consistent earnings, management intention for share buyback, high ROE, full of cash & no debts. By the end of 2015, the company has increase dividend to 15 cents per share, that is 10.7% of $1.40. Will they continue to pay out more? Very possible considered they have 90 million of cash not sure what to do with it. But it is better to buy it when it is cheap compare to current price at $2.90
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8 people like this. Showing 30 of 30 comments
at 2.90 Flbhd is not cheap?
ha ha...that's the same thing they said when it was at 1.40 with div yield as you mention above.....:(
2016-01-16 17:28
Probability I bought it at $1.40, and personally I think it is very closely to fair value of $3. Everyone has different estimates of IV. I know you are creaming at the FCF of Flbhd currently at 28 mil after 3rd quarter. But you need to know these quarters not a normal year cycle. Normalised FCF is mostly sitting at 12-15 mil. If using normalised FCF, EV/FCF of 14x is considered fair for me. In saying that, there are many tailwinds for FLBHD mainly currency and potential corporate exercise on their cash pile since they are not intending to expand the business aggressively. But if you look it as a business that has no moat with healthy balance sheet, good ROE, minimal capex and slow growth, I think $3 is fair. And I agree with management not to invest too much in capex but rather distribute as many cash possible to shareholders. And of course any decision by mgt to distribute those 90 mil cash will change my valuation.
2016-01-16 18:43
JT..using your own normalized calculation on FCF and the EV/FCF of 14x...how many can we find like these in Bursa? Would really appreciate of you can list out a few here for my studies...thanks
2016-01-16 18:50
Hm you can look at Favco. Again their 2015 FCF is abnormal, but if you look at past years average of 70-80mil FCF. EV/FCF is at 5x. Even if you include the possibility of FCF dropping 50% because of O&G sector collapse which to me highly unlikely (they build offshore crane), it is still 10x.
Past few weeks I have a look at Oka Corp. Still studying it. Their FCF turned black since 2013, average FCF of 15mil against EV of 136mil, that's 9x. They just turned net cash these past 1-2 years, so cash is going to start piling up. Other metrics are improving too like ROIC and profit margin. But Im still studying it not much info I can provide. They don't seems to have many competitors, most are private companies. Only competitor is Hume Industries, subsidiary of Hong Leong, previously bought out Narra for their precast concrete business.
I understand what you mean, maybe there's not many bursa companies with 14x, but doesnt mean you have to pay more because you can't find opportunity. The odds (probability) is not in our favour when we pay too much. Let me know if you have any good ones in your list too thanks
2016-01-16 19:10
JT Yeo, there are quite a number. HEXZA is a cash rich company with EV/FCF below 3x for the past 4 years. ECS also has EV/FCF < 7x. The recipe here is to look for companies with high net cash relative to market cap (=low EV) and with good track record of generating free cashflows.
2016-01-16 22:35
+ another point: choosing a dividend stock via screener is not that effective, you need to look into growth of the company and also the projected dividend payout for the next few years.
2016-01-16 23:52
In finance theory, low PE , no growth stocks always give high dividend. Or at least, in theory they should because the company believes the shareholders can use the money more efficiently.
If you invest in Warren Bufett , he never give dividends in his life because he think, and all his shareholders think WB have better use of the money.
Good high growth companies with high PE usually do t give dividends.....or if they give dividends they will also take it back with interest by calling for rights issue.....and diluting the EPS......give figure.
Low PE good or high PE good?
2016-01-17 02:39
Noby how did you get 3x for Hexza? Their FCF for 2013-15 is 18mil, 4mil, -6mil. I don't know much about Hexza except they are in chemical/property business. From a glance, their average FCF from 2006-2015 is about 9-10 mil, against current EV of 131 mil at 13x I think it looks okay.
Just need to be aware the past 4 years FCF can be inflated because their capex is only about 1 mil every year. But when you look at the depreciation rate of 5-6 mil a year, you know they are under investing in capex, they are not spending enough maintenance capex to keep their assets working well, which might potentially hurt future earnings and cash flows.
2016-01-17 06:38
Desa you are right it depends. Berkshire decide not to distribute dividend because WB can compound their book/IV at around 20%, which he think it is hard for his shareholders to find that kind of opportunity.
And in the end it really looks at this business. In the early days Digi decided not to pay out any div too which I believe is to invest in capex to establish a solid foundation. Now that they have a solid market, not much reinvestment opportunity they started distribute large amount of earnings in div. Same as what Amazon is doing, people are buying it in anticipation of future cash flows.
And it depends how you define high growth. I think Scientex is growing pretty healthily and they think a % of div would not hurt their growth.
2016-01-17 06:43
Jobstreet is a company that fits the criteria, it pays 75% of its net profit as dividends, cash rich waiting to acquire new business, quality assets of associated companies of 104 Corporation & Innity as well as listed investments in Hong Kong. Earned about 17 sen in 9 months.
2016-01-17 09:52
JT Yeo, I put in the EV calculation for HEXZA based on 2015 numbers
Price = RM 0.925
Shares outstanding = 200.38 mil
in (RM '000)
Market Cap = 185,35
Cash and non-core liquid assets = 62,150 (cash) + 46,825 (other investments) + 20,014 (Investment in Tembusu)= 128,989
Total debt = 0
Minority interests = 6,797
EV= RM63.16 mil
CFFO = 14,745
Capex = -363
FCF = 14,350
EV/FCF = 4.4x
My bad, the EV/FCF is above 3x but still attractive from your metric, I guess I was basing it on my previous entry price. You re right that HEXZA is under investing in capex. It's core business is not really growing, this is more of a dividend cum net net stock. The growth in profits will mainly come from margin improvement from its disposal of loss making business and new investment venture into Myanmar IPP.
2016-01-17 10:56
Hey thanks Noby for the tip, I though it is a pure play, but looks like Hexza can be an arbitrage play with ROE revision considering the Myanmar venture ROE is >20%. But just need to study more if the effect has already been priced in.
If you are interested in arbitrage play, you can look at Mercury. Similar cases. Used to hold large sum of cash, but used it all up to acquire a construction sdn bhd, Profit guarantee 6.9 mil for each year for next 3 years. It just started last quarter, that why there is a jump, but I am expecting ROE to revise upward soon.
2016-01-17 13:48
JT Yeo, Thanks. Mercury looks interesting ! If I use normalize EPS from existing business for past 3 years and add the contribution of new subsidiary, the forward PE at current price is only 5.7x
However, these are some of my doubts
1. I felt the acquisition done through a related party wasnt cheap. If I purely base on profit guarantee of RM 6.6mil, 70% stake will entitle to RM4.62 mil. Based on acquisition cost of RM 42mil, that works out the a PE of 9x which I deem expensive for a construction outfit with dwindling order book and volatile earnings. Rather than pay the 42 mil outright, I felt that payment should have been done in stages as the profits were secured.
2. The other thing is that the group has never really achieved 6.6 mil PAT only till 2014, do you think they can achieve that in the next 3 years with the current order book lasting till 2017 and fully concentrated in 1 project mainly ?
3. Do you know the background of this Datuk Tiong and the prospects of the subsidiary ? I know he was the one who turned Mercury around previously but had since sold down his stake significantly.
Thanks for your input
2016-01-17 23:14
How about a young growing company making about $ 3 million and paying out $ 1 million in dividends .....
You know why they do it? .because the directors collectively holds close to 70% of the shares.....so the slippage is quite small. The owners are not super rich and they also want the dividends themselves.
How about investing in such a company? You are a true partner in a growing business....it is listed on the KLSE and you too should join the party.
2016-01-17 23:47
a dividend paying stock and a good stock to own is one in which the owners / management have close to 70% of the shares.
still in its growth stage , no institution shareholders yet but will by the end of the year.
2016-01-18 00:39
Hi Noby,
Yea im not sure if that is the fair price as there's nothing for me to compare against. Base on the agreement and orderbook of 100+ mil, they are confident of achieving the 6.6 mil, but should it fell short, they will have to make it up for the difference.
I dont have much details also but they say he is a turnaround guy, he previously turnaround Mercury and Ecofirst. He is the CEO of ecofirst, so he does have experience in construction and property.
Net profit would not increase by much if you take into account the interest expense from their borrowings, if at 6-8% from the banks. The only interesting thing is ROE will potentially revise upward and profit growth. Normally a jump in ROE can boost share price more than growth in profit. And if their paint business gets better or if they land more construction contracts, that's extra. What im seeing is very limited downside, how much is the upside ive no idea. But yea it is for arbitrage not for holding long term.
2016-01-18 04:11
You will always get better dividend if you hold a share in which management have 70 % of the shares compared with holding a share in which management only holds 20% of the shares.
The more shares management have, the better your protection and equity......more accurate, more reliable for forecasting than PE ratio, dividend yield, ROCE or any fancy stuffs you use.
2016-01-18 06:35
You should spend your time listing down the shares in which management have 60% or more of the Company, and choose from there.
2016-01-18 06:38
Keinhin is held 70% by management.....that is why they pay $ 1 million dividends with $3 m profits.
2016-01-18 09:10
Keinhin.....shares are held 70% by directors, management....clearly stated in AR. , shareholders list.
2016-01-18 09:43
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Great post!
Don't forget TMakmur giving 12 cents dividend a year. That's about more than 8%. Far better yield than 3.5% in Savings A/c in any bank.
2016-01-16 16:37