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Dividends: Yay or Nay



Dear Speculators,

Too many a times I have heard people complain bitterly about receiving peanuts as dividends from their stock investments. My first response usually is how much did you buy at and what was the stock actually worth? Too many times we fail to comprehensively value the assets we wish to purchase in the market. Sometimes, we buy based on historical price trends or from hearsays. We say "surely, XYZ stock will go up!" But the market is full of uncertainty. If everyone in the market believes that a stock will go up then no one will sell and every owner will hold. This has never happened!! If you think something will go up, the other person selling it to you believes it will go down. You better make sure you are on the right side of the trade! If the stock neither goes up nor down, it is therefore imperative that we buy the stock at good value if we wish to receive a reasonable dividend from our investment.

For simplicity, let's say only 2 things determines the value of a stock. The forward earnings of the company and the multiples at which it is sold. Let's say we all buy shares in company X which trades in the Nigerian Stock exchange. Its projected earnings is N1 per share and its payout ratio is 40%. The dividend will then be 40 kobo per share. If we buy this stock at 2x earnings, the share value will be N2 per share. Receiving 40 kobo from a stock we purchased at N2 is a 20% dividend yield. If we bought the stock at 4x earnings, share price will be N4 and the dividend indicated yield will be 10%. If we bought the stock at 12x earnings, the dividend indicated yield will be just 3%. If we bought the stock at 40x earnings, the share price will be N40 and the dividend indicated yield will now be only 1%. If we buy at 100x earnings, the dividend indicated yield will be 0.4% and we will be the most frustrated shareholder in the planet. I'm sure with this tiny information we can all find which category we represent. 

We need to realize that dividends are paid out of company earnings not from stock price value. If the company earns zero, dividend is zero regardless of its stock price. If you wish to be a dividend investor, you need to carefully observe the PE ratio of the stock you wish to purchase so that it doesn't erode the potential return to be obtained from dividend in relation to the price you paid for the stock.

Remember even if you buy a bottle of water for N500 when its actual value is N50, the utility derived from the bottle water will still be the same and it won't do anything extra for you. There are numerous stocks in our stock market selling at over 20x multiples like Unilever, Guinness, Nestlé, Nigerian Breweries amongst many others. These are premium companies and everybody wants to own a share in the business. This drives up prices and some shareholders get bitter when they receive dividends. Sorry but they can't pay you more than what they earn! Their dividend indicated gross yield is currently less than 4% according to Bloomberg (as at 22-5-2016). The only way to get good return from these investments is to find another person willing to buy the share from you at a higher price or a higher multiple which we call capital gain. If you want to get great value from dividends then you need to buy excellent stocks at low multiples. Prof. Bruce Greenwald, an expert in asset pricing advices that the best value in investments are obtained from discovering and obtaining desirable cheap and ugly stocks.

Signed:
Emeka Ucheaga,
Managing Partner,
Emeka Ucheaga Advisory

Comments

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