In our previous article on Creating Passive Income From Dividend Investing, we shared on how one is able to create passive income from collecting dividends from stocks. I have received quite a few emails from readers sharing how badly their dividend income portfolio performed on the whole after including dividends.
In this article, I have decided to share a case study on Singapore Telcos, which would best explain what many Singaporeans have faced and an investment metric they could use to analyse such dividend income stocks in future.
When I first started out investing in 2011, I remember how many investors I met were investing into blue-chip companies such as Singtel, Starhub and M1 for their high dividend yields.
One would notice in the chart below, where in early 2011, the Singapore Telcos were trading at dividend yields of more than 10%. That would probably explain the attractiveness of such companies to be included in ones dividend portfolios.
Over the years, the dividend yields started trending downwards from more than 10% to around 5-6%. The reason for this was not because these companies were slashing their dividends but rather investors were chasing these stock prices up resulting in the yields declining.
However, anyone invested into any of these companies, especially in StarHub would be suffering great capital losses over the past 2-3 years.
So how can investors prevent such occurrences from happening?
In my workshops, I often share with my participants how the traditional definition of Dividend Payout Ratio is calculated as Dividends Paid / Profit After Tax. This is to measure the sustainability of the dividends being paid out. Hence, this would mean that anything less than 1 would be ideal as the company is paying out lesser dividends than what net profits the company is making.
However, one has to always question conventional definitions and apply some common sense to it, asking ourselves if it actually makes sense.
In my opinion, the metric should actually be calculated as Dividends Paid / Free Cashflow net of Finance Cost to measure the sustainability of the dividends.
Lets use StarHub as an example of this.
Free Cashflow is the measure of the amount of cash entitled to the firm after maintaining its assets and that cash can be used for:
- Dividend Payments
- Reduction of Debt
However, that cash does not include interest payments.
Therefore, for a company like StarHub, which requires huge amounts of debt to operate with, I would compare the dividends paid with its Free Cashflow net of Finance Cost, which is essentially the interest payments on its debt.
Looking at the table below from FY2013 to FY2016 for StarHub, one would notice that based on conventional dividend payout ratio calculations, the dividends of StarHub is quite sustainable. This is because the dividends paid has always been lesser than the net profit of the company.
However, if one were to compare the dividends paid with Free Cashflow net of Finance Cost, one would notice that the dividends is not sustainable and that the company is running a huge shortfall every year. This resulted in StarHub having to raise a debt of SG$300million in FY2016 to continue paying such high dividends and subsequently having to slash their dividends to what it is today as the dividends paid in the past was never sustainable.
As investors, I understand the allure of wanting to invest in high yielding dividend stocks. However, do not become yield obsessive and always ask ourselves this question – is the dividends sustainable? Compare it with the company’s free cashflow rather than following traditional formulas on dividend payout ratio.