Since the earliest days of investing in companies run by other people, investors have attached a special importance to dividend payments. Whether looking for income and a bit of capital growth or searching for undervalued shares, the regular payment of dividends is still seen as a sign of a solid, well-managed company.
Disaster often awaited investors who took a radical view and based their investments on other criteria, such as the number of clicks an internet company generated on its website during the dot-com era of the 1990s. Or the belief that property prices can only increase, which led to the great financial crisis in 2008, similar to the crashes in property markets of 1880 and 1970.
Admittedly, newer and more accurate valuation techniques, such as sophisticated discounted cash flow models and volatility measures, are nowadays essential in the complex investment world, but investors still keep an eye on a company’s ability to declare dividends.
Solid and boring is good
Add a reasonable share price to a plump dividend – generating a high dividend yield – and the result is usually a good investment opportunity. Sometimes boring, but still good value. Companies that pay bigger dividends are usually mature, with a long history and proven management. They are financially stable, have strong balance sheets and produce steady and growing profits every year.
One of the best examples is the previously listed Lion Match Company (now a subsidiary of Fasic Investment Corporation). It was highly profitable and rewarded its shareholders with high dividends every year while listed on the JSE. But manufacturing a product designed a few hundred years ago didn’t win it a lot of new friends.
As long as a share’s high dividend yield indicates these fine attributes, investors should expect good returns over the long term. Dividends can be used to invest in the same or other high-yielding companies which will lead to the benefits of compounding returns.
When to be wary
However, a high (historic) dividend yield can also mean that investors are uncertain of a firm’s prospects and do not expect a high dividend in the next financial year. In this case, the high dividend yield results from a low share price that reflects that investors dumped their shares after realising that the company’s prospects had worsened.
Thus investors should rather use the forward dividend yield as a yardstick, using the expected dividend over the next 12 months to calculate the forward dividend yield. A case in point is the prospects of companies operating in very cyclical industries, such as mining groups and commodity producers.
Investing with the focus on dividends enjoyed a spell of popularity after the 1991 publication of Beating the Dow, a book by Michael O’Higgins, which suggested a ‘Dogs of Wall Street’ investment strategy. O’Higgins proposed a simple investment philosophy of always investing in the so-called dogs – shares ignored by most investors and thus trading on lower prices, but still maintaining healthy dividends. In essence, seeking shares with the highest dividend yields.
The investment strategy is based on selecting a universe of dividend paying shares and investing in the 10 shares that offer the highest dividend yields. In other words, investors will always choose the 10 shares with low prices relative to their dividend distributions.
If share prices increase when those shares become more popular with investors and the shares move towards the top end of the universe – the 10 shares with the lowest dividend yields – it is time to sell them out and re-invest in the new dogs.
In its simplest form, the O’Higgins strategy assumes a big enough number of stable companies paying dividends year after year. By implication, it presumes that little more research is necessary than watching the share prices as measured in terms of the changes in the historic dividend yields.
There are only a few shares on the JSE that would meet this rather narrow, even academic, requirement. Lion Match was one, while Reunert, Telkom, Astral Foods and Caxton might be considered as such.
We were still able to identify more than 20 shares that offer investors high forward dividend yields. Among these are a surprising number of the largest companies on the JSE, such as MTN Group, Vodacom, and Kumba Iron Ore.
Investors would need to do some work and rely on earnings and dividend forecasts to get the most out of a dividend investing strategy. This immediately creates a few problems.
Some technical challenges
The biggest problem is that all analyst forecasts are done according to a company’s financial year, while investors need uniform forecasts for the next 12 months to be able to compare different shares’ dividend yields with each other. For instance, the consensus forecast of the dividend per share forecast for a company with a June year-end and that of a company with a March year-end are two different things. One company might already have paid an interim dividend to current shareholders, but it still forms part of the forecast figure for the current financial year.
A second problem is the timing of dividend declarations and payments. Most companies pay an interim and a final dividend, but some only pay one annual dividend at the end of the financial year. Even forecasts on the world’s premier financial system, Bloomberg, need to be checked share by share to ensure that forecasts are up to date.
We tried to take these factors into account when calculating the forecast dividend yield on our list of shares. Our calculation of the forward dividend yield (table 1) is based on the dividends an investor can expect over the next 12 months, either an interim and final dividend of a single financial year or a final dividend due for the current financial year plus the interim for the next year.
|High dividend shares||Price||Forecast DPS||Forecast DY %|
|Kumba||29 151||1 995||6.8|
|Assore||29 500||1 990||6.7|
|Billiton||30 945||1 778||5.7|
|Combined Motor Holdings||2 700||155||5.7|
|Astral Foods||28 991||1 580||5.4|
|Anglo||29 844||1 544||5.2|
|BAT||75 461||3 707||4.9|
Source: Author’s research, adapted from available consensus forecasts; refer to article for details.
Top of the list is Verimark on a forward dividend yield of 12%, actually somewhat lower than its historic dividend yield of 15%. The lower figure is probably due to the fact that very few analysts follow the small company and forecasts are not updated regularly enough. Nevertheless, Verimark’s dividend yield is high because the company produces satisfactory profit without having to re-invest large amounts of capital. It sells fast moving goods, mostly in other people’s stores. Another factor is that the share does not trade often as current shareholders are simply not willing to sell to eager buyers and the share price does not reflect its intrinsic value.
Assore, on a forward dividend yield (FDY) of 6.7% and traditionally seen as a high dividend stock, is on the list just behind Merafe Resources (on a FDY of 8.8%) and Kumba (6.8%). They all operate in the uninspiring business of blast, scoop, truck, crush and sell, which returns a solid profit in good times with little need for huge capital expenditure, but no possibility of remarkable new products and explosive growth.
An interesting and exciting entry that offers a high dividend yield is Coronation Fund Managers on a FDY of 7.8%. Coronation’s dividend has shown strong growth over the last few years and analysts seem to expect further growth over the next few years, while the share price has lagged the firm’s growth and good prospects.
Communication firms Vodacom, MTN and Telkom are all on the list for more or less the same reason. They are all now enjoying the fruits of years of expansion, high capital expenditure and very strong growth that resulted in enough clients to ensure good profits and strong cash flow, and high dividends.
A few international shares, namely British American Tobacco, Anglo American, BHP Billiton and Glencore deserve special mention. Although not usually regarded as stocks to consider for their rich dividends, the decline in the value of the rand puts them on the list for consideration. Dividends payable to SA shareholders in these international groups are converted to rands at the ruling exchange rate when dividends are paid.
We have converted the forecast dividend for these companies at the ruling exchange rate of R14.57 to the dollar and R18.82 to the pound. The exchange rate six months and 12 months from now will determine the actual dividends local investors will receive over the next year.
Despite somewhat lower forward yields, dividend investors should also consider banking shares. SA banks are stable, well-run businesses with sufficient capital reserves operating in an environment characterised by efficient regulation. Each has the backing of a strong holding company.
|Bank shares||Price||Forecast DPS||Forecast DY %|
|Absa||16 261||1 124||6.9|
|Nedbank||26 383||1 429||5.4|
|Standard Bank||18 925||971||5.1|
Source: Author’s research, adapted from available consensus forecasts; refer to article for details.
Banks’ prospective dividends put their shares on forward yields of just more than 5%, with FirstRand lower at 4.7% and Absa the highest at 6.9% according to available forecasts.
The long list of listed real estate investment trusts (Reits) offers good prospects for those investing for dividends. Simply put, an investor either becomes a lender to the property company and the Reit basically pays them interest, or they can be seen as one of the landlords and the Reit pays them their part of the rental income. In most cases, it is a bit of both.
Investors are spoilt for choice and can invest in whatever sector of the property market they prefer, from retail shopping centres or corporate office blocks to commercial property. The popularity of Reits and strong growth in the sector can be seen from the fact that several property companies are included in the JSE Top 40 index. A quick look at the historic dividend yields of some of the popular Reits shows that investors can expect yields of around 10%.
An investment strategy based on the dividend yield works well for investors who are not necessarily looking for shares with exceptionally high dividends. The strategy is also a useful way of finding undervalued shares. Using the strategy on the largest 50 shares on the JSE, or an investor’s preferred universe, would deliver good results.
It needs to be said that there are good shares which pay only small dividends, where management’s stated aim is to continue reinvesting profits, rather than paying available cash out as dividends. In theory, shareholders benefit from capital growth in the share price.[“Source-moneyweb”]