Revisit: Invest in one that grows!

Where capital appreciation and long-term yields are our investment goals, putting our hard-earned money in a company that grows (its earnings) is probably more important than one that gives out high dividend payout in terms of yield (yet has poor cash flow and does not grow its revenue much). One metric to look at would be Earning Yield. It is the inverse of P/E and expressed as a percentage. We can use Earning per share divided by Price per share. A higher than normal earnings yield indicates the stock may be oversold, provided nothing negative happens.


However, we should not simply rule out dividend yield in our buying consideration as companies that give good dividend yields are generally less volatile than those that do not give out dividends. This is because fund managers in times of bad market would rather sell off the shares of the company that give less dividend before the one that do if both trades at the same price [source article here]. So we can infer that good yield could give some kind of cushioning against extreme price drop in times when the stocks market crashes. When considering dividend yield, look also at the company's payout ratio which I would elaborate.


The difficulty always lies in spotting that healthy 'chicken' to lay our 'golden eggs'. The golden eggs here refers to BOTH capital appreciation and dividends. In choosing the 'golden chicken', below are some pointers to note.




1) The company should have 3 consecutive years of positive margin.


2) Companies that earn a profit can do one of three things: pay that excess money out to shareholders, reinvest it in the business through expansion, debt reduction or share repurchases, or both. The company should ideally pay out 50% or less of profit as dividend so as to use the rest in business growth. This can be derived from the payout ratio.

The percentage of net income that is paid out in the form of dividend is known as the dividend payout ratio (read more). This ratio is important in projecting the growth of company because its inverse, the retention ratio, can help to project a company’s growth. A high payout ratio may not be sustainable in the long run unless you are looking at REITs or large companies with stable income and slow growth.


3) Dividend yield is consistent between 2 to 6%
Dividends are dependent upon cash flow^ of the company, not its reported earnings.


4) High ROE with little corporate debt
One way to analayze ROE is to break it down using DuPont Analysis.

DuPont Analysis Formula:

ROE = [Net Income / Sales] x  [Sales / Average Total Assets] x Equity Multiplier
where Equity Multiplier = Total Assets / Total Shareholder’s Equity

If ROE is high due to the first two components, then everything's good. HOWEVER, if ROE is high mostly due to the Equity multiplier component, then it is not so good.
Any increase in the value of the equity multiplier would result in an apparent increase in ROE. A high equity multiplier shows that the company incurs a higher level of debt in its capital structure and it reduces the overall cost of capital. Read more here [external link].


All of the above information can be obtained by scrutinizing the balance sheet and annual report of the listed company and from there we can have a better understanding of its revenues and financial health. Numbers being numbers, we should also not forget to find out what sustained the numbers and made the business great. Yup, that's the intangibles.

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REITS

For REITs, we want to buy those with increasing DPU, long WALES, relatively low P/B ratio, high-occupancy/value properties (translating to high FFO) and not over-leveraged (in SG there's a regulated limit of 35%) by calculating the FFO to debt ratio. FFO to debt ratio tells us how long it takes for a REIT to pay off its debt using its income from its main business activities.


Do take note too of risk factors such as the current economic cycle, industry outlook, currency risk (especially those with assets oversea and earnings are in the foreign currencies) and loan interest (as REITs can be highly leveraged).

We could also look at other factors when choosing the REITs such as the quality of properties it owned, property types, geographical location, total assets value, how is the REITs being managed (structure preferably not too complex, management fee %), REIT's sponsor and the REIT's Weighted Average Lease Expiry (WALE).

Recommended reading - Investing in Reits by Ralph L. Block

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Related posts:

Buying into the right business
Payout Ratio, Operating income and recent Watchlist



Revised post previously published on 9 June 2018.

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