Dividend is important for many reasons. The most important reason has been explained a chapter earlier on, that is, dividend is the only benefit which a shareholder can obtain from a company under the normal circumstances. Profit, per se, is hardly of any use to him directly and the assets are only of value if the company is liquidated which is unlikely in a great majority of cases. Apart from this reason, dividend is important for the following reasons:
1) Dividend is a sure thing.
All too often, investors and speculators pay too much attention to profit forecast. It is amazing that so many malaysian companies have the courage to make profit forecast for many years into the future. What is even more amazing is that so many of the investors seem to believe these forecasts absolutely. It is difficult to make a profit forecast a year ahead, let alone five years or even ten years. Such profit forecasts can only be regarded as extremely shaky.
Let us take a recent example. During 1981, when the “property injection game” was at its height, many of the companies which were first getting into property development business gave very rosy forecasts of future earnings potential, as a result the price of these shares naturally went up to tremendous heights. Since then, the housing market softened considerably and the office rental market has declined 40-50 per cent. In just three years, the profit picture of just about all land development companies has changed considerably. I wonder how many of those forecasts made in 1981 can still stand up to scrutiny today.
Dividend is real and it is something which the shareholders can put to some use. Most companies keep dividend at a level they can afford to pay out irrespective of whether it is a good or bad year and is hence a great deal more certain than profit forecast.
2) Dividend provides a link with reality.
When the market is truly ‘hot’, few of us can keep truly rational and we tend to be swept along in the general atmosphere of optimism. But the dividend yield of a share keeps us in close touch with the real world. Anyone who keeps his eye on the dividend yield of that share would have realised that the price level was totally unreal. Most people would agree that at a dividend yield of 0.4 per cent it would be better to sell a share and invest the proceed in houses or leave the money in fixed deposit.
In the established stock markets of the world, the dividend yield (ie dividend per share/price per share) usually has a steady relationship with the fixed deposit and its interest rate. It is normal for dividend yield to fluctuate at around 1/3 to 1/2 of the long-term deposit interest rate. This means that when fixed deposit interest is around 10 per cent per annum, stock should sell at a price to provide a yield of 3 per cent to 5 per cent. Taking a look at the yield provided by local shares during bull markets, the dividend yield is usually so low as to be meaningless. Futhermore, one should not forget that fixed deposit of 15 months or longer and fixed deposits in National Savings Bank are interest free in Malaysia while dividend has a witholding tax of 40 per cent applied at source.
3) Dividend provides a ‘floor’ for shares during bear markets.
Stock markets of the world, especially the Malaysian/Singaporean market is not readily predictable. They can collapse so easily into a ‘bear pit’ with little warning. If we wished to protect our hard earned capital, we must be defensive in our investment approach. One of the best defense is to buy shares with reasonable dividend yield (i.e. a yield of between 1/2 of deposit interest rate). If we buy a share because it pays a reasonable dividend, our loss is likely to be small even during periods of sharp market decline.
For example, we can buy a share which pays 30 cents dividend at Rm5.00 a share and this gives us a dividend yield of 6 per cent. If the share market goes into a sharp decline, the amount this share can fall to is limited by the fact that it pays a 30 cents dividend. If the price is to fall to as low as Rm3.00, it will be giving a dividend yield of 10 per cent which is about as good as what one can get from fixed deposit but with the additional opportunity to capital gain thrown in.
Most people can see that at that price, the share is probably a good bargain and it is therefore unlikely to fall any lower.It has been my experience that with the exception of mining counters, a dividend yield of 12 per cent seems to be the floor below which most stocks will not drop. In sharp contrast, shares which pay low or no dividend at all do not seem to have any bottom and price decline can hit 90 per cent or more.
4) Dividend yield prevents investors from being side-tracked by irrelevant events.
The Malaysian/Singaporean stock market can be characterised by a large number of events which are of little real benefit to the existing shareholders and yet which excite them greatly. I am referring to the large number of bonus announcements, rights issues, property injections, take-overs, and mergers which have made their appearance in recent years. Most of these events are of little, if any, real economic benefit to the existing shareholders of the companies involved.
Despite this, the price of the shares of a company involved in an event of this nature tends to rise sharply. Later chapters will explain in detail why these events are, in the main, irrelevant and some of them may even be damaging.
For the moment, let us consider the following. According to the dividend yield approach to share valuation, a share can have increased value only if there is a likelihood that its dividend will rise faster than originally expected. We ask ourselves in what way events like bonuses, rights, mergers and re-organisations in themselves can improve the future dividend picture of a company. If these events cannot lead to such an increase, the share surely does not deserve a higher valuation.
It is hoped that readers are, by now, at least partially convinced of the wisdom of buying a share for its dividend. In later chapters, the range of dividend yields which is reasonable for different categories of shares will be examined. In the meantime, I leave you with a short ditty that has been popular for years in the US and is still often quoted as advice to first time share buyers.
A cow for its milk,
Bees for their honey,
And shares, by golly,
For their dividend.
The above passage is taken from the book “STOCK MARKET INVESTMENT” in Malaysia And Singapore
By Dr . Neoh Soon Kean of Dynaquest Sdn Bhd (pp 148 to 150) Published in year 1985.