Dividends: A Passive Income

Dividends are payment made by a company to its shareholders, usually out of its profits. Dividend policy varies from company to company. For example, some company do not pay dividends regularly. Others, like Singpost, pays dividends every quarter. Hutchison Port Trust pays bi-annually and Straco pays yearly.

People view dividends as an added bonus when they trade stocks. For an investor, dividends may be the make-or-break decision for buying the stock. This is because in the long run, dividends eventually becomes your passive income. One good example is Dividend Warrior, who regularly blogs about his dividend returns and income. In the latest 13 August 2014 post, he had accumulated $10,262 of dividends. These dividends are based on a capital of $222,560. That is my idol right there!

Usually when I tries to preach about the importance of investing for passive income, the usual response is that the capital is too low to start. However, I beg to differ. Everyone must start at some point and when better to start than now? For young investors, the most precious asset you own is TIME! Given that your capital returns an interest of 5% per annum and that you reinvest your interests, $1000 will become $2000 in 14.4 years. Make your money work as early as possible! In addition, SGX will cut lot size from 1000 shares to 100 shares by 19 January 2015. Currently, you can only buy stocks in blocks of 1000 shares, or 1 lot. By next year, you can purchase stocks in blocks of 100 shares. This means that blue chips like DBS or Keppel Corp will be more affordable to the public.

The gains to be made from investments are from either capital gains from rising share price or dividends. Although capital gains are usually gained in a shorter period of time and thus more satisfying, a smart investor will realise that dividends pay well in the long term. Everyone looks forward to retirement eventually and living expenses after retirement generally comes from CPF. But what if you manage to build a sizeable portfolio by the time you retire? Instead of putting your cash into a saving accounts which yields less than 1%, put it into dividend-yielding stocks like REITs and Trusts. These two types of stocks usually yield at least 5% dividend a year. In addition to CPF withdrawal, dividend payment can really add to the comfort of your retirement. For me, investment is really about building a portfolio that can eventually provide enough dividends for financial freedom/retirement. That should also be the objective that other have for investing.

As a result of my love for dividends, I had been slowly buying dividend stocks like Trusts and REITs the past 2 years. Below is my humble dividend records in the last two years of investing:

Do note that Dividend Yield reflects average yield of only dividend-bearing stocks while Portfolio Dividend Yield is the dividend yield based my enlarged portfolio capital.

I've highlighted the benefits of dividends in investing and also briefly covered how time is our most precious asset. Also, I've mentioned about two categories of stocks, REITs and Trusts, which bears comparatively higher dividend yield. Hopefully after this post, you might give investing a good thinking over and start your own investing journey!

Straco: Art of Pricing Stock Price

When looking for stocks to invest in, there should be a fixed tangible strategy in place. In that way, it is really  investing and not just a game of luck and chance (aka gambling). For me, I use the methodology set out in the book written by Mary Buffet (check out my reading list post). To scout for stocks, the company must have:
1) a competitive economic moat, and
2) a steadily increasing EPS.

Competitive economic moat refers to the high entry barrier that a certain business may possess. For example, setting up a bakery is easier than setting up a smartphone company. A bakery may need bakers, baking equipment, retail space and cashiers. A smartphone company needs the patents and technology, supply chains, distribution lines.. not to mention the manpower! Between these two types of companies, which do you think is easier to set up? Companies with high economic moat mean that their businesses are not easily threatened and margins may be higher. Choosing to invest in these companies ensures your investment has high level of security against business failure.

Mary Buffet also stated that Warren Buffet liked companies with increasing EPS over the years. The companies he mentioned in the book include Coca-Cola, Johnson & Johnson and Kraft Food. It signals the strength of management and business. Furthermore, the intrinsic value of stock can be calculated from the EPS growth.

In my case study, I'll use Straco priced on 18 Aug '13 as an example. The closing price was $0.775.
Straco (S85.SI) is listed on the Mainboard of Singapore Exchange. The company owns and manages a number of tourist attractions in China. These include Shanghai Ocean Aquarium, Underwater World Xiamen and cable car services at Xi'an. It had also ventured into entertainment business with startup of Straco Creation Private Limited.

The EPS of Straco over the years are as follows:

Year Earnings per share (cents) 2005 0.34 2006 0.39 2007 0.71 2008 0.89 2009 1.02 2010 2.15 2011 1.91 2012 2.31 2013 4.01

From the EPS, you can see that Straco has a steadily increasing EPS over the years, barring the drop between 2010 and 2012. This may be the sort of business you want to be interested in. Though Straco certainly isn't the sole player of tourism in China, it is the first few and enjoys the first-mover advantage. Furthermore, China is increasingly into domestic tourism which is positive for the company.

Once you determine that the business model and EPS growth is satisfactory, you can proceed on to estimate the intrinsic value of the company. The steps are shown below.

First Step (Finding CAGR):

Between 2005 and 2013, in which 8 years have elapsed, the EPS of the company has grown from 0.34 cents to 4.01 cents. Using a CAGR Calculator found here, find the CAGR of the EPS. 

Input the data accordingly:

Beginning value: 0.34 (starting EPS)

Ending value: 4.01 (ending EPS)

Number of periods: 8 years (years elapsed)

If done correctly, you will yield a CAGR of 36.13% per year. 

Second Step (Finding the Future EPS):

Once you have establish how fast the EPS is growing, you can estimate the EPS the company will earn in the future. First, you must determine the time frame for the stock investment. For me, I am more interested in the middle term time frame (~ 5 Years). 

With the time frame decided, proceed to calculate the future value of EPS with Future Value Calculator. 

Input the data accordingly:

Interest Rate Per Time Period: 36.13 (this value is the CAGR obtained earlier)

Number of Time Periods: 5 (your desired time frame here)

Present Value: 4.01 (latest EPS of the company)

If done correctly, you will yield a result of 18.75. This is the estimated EPS of the company in 5 years' time. 

Third Step (Establishing the Future Stock Price):

The EPS of the company is estimated to be 18.75 cents ($0.1875). Now, how do we translate this piece of information into stock price? That depends on the price-to-earning ratio (P/E) of the company in 5 years' time. Once again, we have to estimate the P/E of the company. You can do that by studying the historic values of the P/E ratio.  

Being more conservative, I set the model P/E at 8. Normally, P/E is between 10-20.

To get stock price, multiply the EPS with P/E. Therefore, Stock Price = $1.50

Fourth Step (Deal or No Deal?)

The current price of Straco is $0.775 while the predicted value is $1.50 in 5 years. This is an increase of 93% in 5 years. Also take note that the increase is not including dividends! 

Make sure to double check that the calculations have been accurate enough. Take note if there had been one-off gains in EPS and strip it off accordingly. 

When everything is done and the potential return proves to be tempting, the hardest part will be to press the buy button.