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Secrets of dividend investors
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Two key factors: dividend safety + capital preservation
Dividend safety
1. Credit analysis
1a. Will you lend $ to the company if you are the bank? (willingness & ability [cash flow, what if scenarios] to pay, collateral)
1b. Credit ratios
1bi. Leverage ratios:
-- debt to asset
-- debt to equity
1bii. Liquidity ratios:
-- current assets to current liabilities ("current ratio")
-- cash & equivalents + marketable securities + a/c receivables) to current liabilities ("quick ratio")
1biii. Coverage ratios:
-- "earnings before interest & tax" to interest expense ("EBIT interest coverage")
-- "earnings before interest, tax, depreciation & amortization" to interest expense ("EBITDA interest coverage")
2. Dividend sustainability
2a. Comfortable dividend payout ratio
2b. Dividend payment track record
2c. Earnings risk
3. Dividend yield
3a. Yield > 10 year government bond yield
3b. Payback period acceptable (5% yield => payback period = 20 years)
4. Valuation
"Perpetuity dividend discount" model
P = D / (k - g)
P = reference price (possible entry point for long term conservative dividend investors)
D = average annual dividend
k = cost of equity = risk free rate + beta x equity risk premium
e.g. k = 3% (10 yr govt bond) + 1 (market) x 6% = 9%
g = perpetual growth rate in dividend
e.g. g = long term GDP growth rate of a developed economy = 3%
So, P = D / ( 9% - 3%) = D / 6% i.e. buy if dividend yield is above 6%.
Capital preservation
5. low financial risk (less debt, longer debt maturity, higher proportion of fixed rate debt)
6. low business risk (products/services non-discretionary, lower proportion of fixed costs, less working capital/capital expenditure for sales growth)
7. high returns on investment (ROE, ROA)
8. good growth prospects (take market share from competitors, go into new markets/products/customer segments, M&A - risky)
9. ANAV approach (adjusted net asset value -> adjust down trade receivables, inventories, investment properties & listed investments, intangible assets / goodwill, adjust up liabilities)
10. 2RV approach (V: value according to 4 above, must be high, R: risk must be low, R: return must be reasonable)
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Two key factors: dividend safety + capital preservation
Dividend safety
1. Credit analysis
1a. Will you lend $ to the company if you are the bank? (willingness & ability [cash flow, what if scenarios] to pay, collateral)
1b. Credit ratios
1bi. Leverage ratios:
-- debt to asset
-- debt to equity
1bii. Liquidity ratios:
-- current assets to current liabilities ("current ratio")
-- cash & equivalents + marketable securities + a/c receivables) to current liabilities ("quick ratio")
1biii. Coverage ratios:
-- "earnings before interest & tax" to interest expense ("EBIT interest coverage")
-- "earnings before interest, tax, depreciation & amortization" to interest expense ("EBITDA interest coverage")
2. Dividend sustainability
2a. Comfortable dividend payout ratio
2b. Dividend payment track record
2c. Earnings risk
3. Dividend yield
3a. Yield > 10 year government bond yield
3b. Payback period acceptable (5% yield => payback period = 20 years)
4. Valuation
"Perpetuity dividend discount" model
P = D / (k - g)
P = reference price (possible entry point for long term conservative dividend investors)
D = average annual dividend
k = cost of equity = risk free rate + beta x equity risk premium
e.g. k = 3% (10 yr govt bond) + 1 (market) x 6% = 9%
g = perpetual growth rate in dividend
e.g. g = long term GDP growth rate of a developed economy = 3%
So, P = D / ( 9% - 3%) = D / 6% i.e. buy if dividend yield is above 6%.
Capital preservation
5. low financial risk (less debt, longer debt maturity, higher proportion of fixed rate debt)
6. low business risk (products/services non-discretionary, lower proportion of fixed costs, less working capital/capital expenditure for sales growth)
7. high returns on investment (ROE, ROA)
8. good growth prospects (take market share from competitors, go into new markets/products/customer segments, M&A - risky)
9. ANAV approach (adjusted net asset value -> adjust down trade receivables, inventories, investment properties & listed investments, intangible assets / goodwill, adjust up liabilities)
10. 2RV approach (V: value according to 4 above, must be high, R: risk must be low, R: return must be reasonable)