Imagine having cash passively deposited into your account every half a year. Nope not from your usual day job or work that pays you for your service.
Most companies in the stock market gives out dividends to their shareholders (people who bought their stocks), as a form of reward or to retain shareholders. The company distributes a portion of their cash they earned from their products/services to shareholders. Not all companies give out dividends as some management may feel that the company can use the cash to further grow their company and decide not to give out dividends.
Usually, for any particular company their dividend yield do not extend beyond 5%, let’s not talk about REITs as its an another investment vehicle altogether. So today I want to talk about how to achieve more than 5% dividend yield.
1) What is dividend yield?
Basically, dividend yield is the amount of dividend given per share divided by its share price.
So for instance lets take a look at ST Engineering,
They give out 2 times of dividends in 2017, $0.10 and $0.05 respectively. So dividend yield on the current share price amounts to be about 4.32%.
$0.15/$3.47 x 100 = 4.32%
So if you are vested in ST Engineering for the entire 2017, you would have received 4.32% return just on the dividends alone (not inclusive of capital appreciation if any). In that sense, this is “free money” given to you if are invested in a company stocks.
2) Why would anyone prefer a dividend strategy?
In any dividend strategy, we are looking towards a long term investment horizon of a few years of holding that particular stock ( I mean no point buying for just 1 year of dividends as the return is minuscule of 3-5% only). So normally people who uses a dividend strategy are people who do not want to actively manage their investment, or do not want to take too much risks in their investment (since they can just live off the “free money” given by the company).
Building a portfolio of stocks for people of this profile means that the stocks chosen have to be sustainable in their dividends (you would not want a company to give you 10% this year and decides not to give anymore dividends next year). By sustainable I mean that the company must not be over-stretching themselves just to give out dividends. Imagine a company having to borrow money from the bank just to give you dividends, sooner or later they would have to find ways to finance those debts which is not good. A good dividend company would be one where giving out dividends does not affect their core operations.
That’s why most people who employ a dividend strategy prefers buying blue chips as they are big enough and have a history of giving dividends.
But if you realise most blue chips dividends yield are in the range of 3-5%, very little actually surpass the 5% threshold.
3) Breaking the 5% threshold
Breaking the 5% threshold would require you to pick company in the middle of their growth phase and hold it for years. Before any company become a blue chip they all have to start somewhere small.
So where we should look for are middle size companies that are only starting to give out their first or second year of dividends. When a company decides to instate a dividend policy this is usually only after the company feel that they are large enough and are able to now consistently give out dividends to their shareholders.
Using this concept above, we shall look at some examples.
In the example of ST Engineering above, the very first time that they gave out dividend was in 1998, when they just got listed. In 1998, they gave out $0.18 worth of dividends, that amounted to about 5.19% that year.
Imagine that you now decided that you will buy ST Engineering in 1999 after you have studied their fundamentals and feel that its a growing company with the ability to sustain their dividends into the future. In Jan 1999, you bought ST Engineering at $1.50 per share. Fast forward to today, in 2017, your dividend yield for this year alone is 10%.
$0.15/$1.50 x 100 = 10%
And if you realise, you also benefit from the rise in share price. At $3.47 in 2017, you would have gain 231% just based on share price appreciation since you first bought back in 1999 (not counting the amount of dividends you collected from 1999 all the way up to 2017).
So if ST Engineering can keep up with giving $0.15 per share of dividends or even increase their dividends for the next 10 years, you are looking at a 10% return every year. (Sooo much more than the bank!)
We take a look at another example, Sheng Siong.
Sheng Siong started paying dividends in 2012 at 2.89% dividend yield.
Imagine now that you have decided that Sheng Siong is fundamentally sound and will be able to sustain their dividend payout. You decided to buy in 2013 at $0.539 per share. Fast forward to 2017, your dividend yield would be 6.3%.
$0.034/$0.539 x 100 = 6.3%
Share price appreciation would have been 178% just based on share price alone. If Sheng Siong can continue to sustain or even grow their dividend payout, your dividend yield will grow beyond 6.3%!
4) Is this too good to be true?
Yes! Employing this strategy requires more research than just dumping your money into existing blue chips. What you are doing here is buying the blue chips of tomorrow. Not every company that gives out dividends for the first time can sustain them throughout the next 10 years. They KEY here lies in choosing the ones that will.
So checking out their fundamentals, the management and future prospects are all equally essential to the success of this strategy.
breaking the 5% threshold is easy if you are patient enough to hold a stock for years and choosing the right company at the right stage before it becomes a blue chip kind of status.