I’ve lost sums of money investing in dividend stocks. These are some of my lessons, and what I’ve learnt along the way.
It’s easy to get hooked on dividend stocks. The premise is simple; buy shares of companies which are profitable and collect dividend payouts for the rest of your life.
In reality however, dividend investing has it’s Pros and Cons and isn’t as straightforward as others make it out to be. Although true that investors can receive income from dividends, this only happens when the company puts on a good show.
If you’ve been paying attention, you would likely have heard of companies like Sembcorp Marine and First REIT. Whilst previously assumed to be solid dividend bets, these companies have now deteriorated to the point where their dividends are affected.
Furthermore, those who invested in such stocks would have likely lost much of their vested capital. As demand for these counters tend to fade away due to the fear and uncertainty of future earnings.
These are not one-off events, which raises the question; are the dividend stocks in my portfolio safe? And what can i do to minimize the possibility of such an event happening to me?
Although we can’t predict everything that might affect a dividend stock, some factors do have obvious tell-tale signs. If we identify and understand these factors, we would be more aware of what affects a dividend stock, and select our investments accordingly.
Generally speaking, these counters tend to have excellent and predictable cash flows, derived through profits from proven business models. This stream of income is what allows these companies to pay out consistent dividends to investors.
The key word here is Business Model. Without a strong model, the entity is unlikely to be able to generate cash to pay dividends. This also applies if the business model is disrupted by internal or external factors in any way.
This can come in the form of technological advances, regulatory change, or receding market demand. Such pitfalls generally do not occur overnight, allowing conscious investors to forecast and sidestep them beforehand.
In the case of Comfortdelgro, we can observe that while the company held a dominant position in the taxi industry for decades, the advent of ride-hailing apps such as Uber and Grab altered it’s business prospects drastically. With cash flows eroded, the company decided to decrease it’s dividend payout in 2019.
Let’s consider the earnings nature of certain dividend payers. While some Utilities and Telecommunications counters have pretty consistent revenues, others tend to be quite “chunky”. This factor normally ties in with their operating industry.
The idea is that companies which operate on a project-based model such as Property developers, or in accordance with demand like Property agencies, likely have payouts which can fluctuate widely.
As a result, their dividends can vary greatly depending on earnings for the period. However, this doesn’t make them bad investments, we just need to be aware of these characteristics and avoid buying in when big dividends are announced as the value of the payout is likely reflected in the share price.
The Singapore property market has been good to property agencies in the past two years. Consequently, earnings and payouts for both APAC Realty and Propnex have reached new highs as both entities experience a surge in demand for their services.
However it wasn’t as rosy before, as investors had to contend with lower payouts in accordance with lower fees earned by the agencies.
While profitability is a given for some companies, cash flows can still be affected by certain conditions. Reasons include more industry competition driving down prices, or the characteristics of the offered product or service.
Such market dynamics can seriously affect profit margins for businesses, resulting in lesser cash flow and smaller dividends. As companies struggle to attract customers, they might resort to lower prices and giving discounts to increase or maintain their market share in accordance with their strategy.
An appropriate illustration would be the local Telcos such as Singtel, M1, and Starhub. This oligopoly which lasted over a decade, allowed these Telcos to dominate the market and collaborate in prices offered to consumers.
Only with the entrance of TPG and other MVNOs did competition start to heat up, leading to lower prices for consumers and lower margins for these companies as well.
We also know that the inherent value of mobile data is not pegged to any particular operator. Therefore, consumers have greater initiative to choose the cheapest candidate.
This factor relates to the choices made by management as to how profits should be utilized. While some companies choose to reward shareholders with dividends, others might decide to commit their earnings to growth instead.
It’s important to look up the dividend policy of your invested company to get an inkling of dividends you are likely to receive. This statement is given by management and normally followed through in most circumstances.
A more significant change would be if management states it’s intention to discontinue a dividend policy due to a change in strategy. A fitting case study would be AT&T, whose leaders have indicated it’s intention to cut dividends from 60% to 40% due to a subsidiary spin-off.
At the end of the day, a business will still fail without strong and sustained demand for it’s goods and services. While demand might seem upbeat at present, this is not a given and could reverse due to market conditions or certain factors.
Since strong demand drives up prices, a reversal would normally cause both prices and volumes to drop accordingly. This can have a knock on effect on revenues and profits, leading to poorer business prospects and lower dividends.
During 2020 as the pandemic ravaged the globe, international travel was put on hold indefinitely. In return, this had a negative effect on companies which operated in the travel industry like Airlines and Hotels.
Consequently, many of these establishments ran into cash flow issues and had to lessen or cut dividends to investors. Well-known examples include local companies like Singapore Airlines and Far East Hospitality Trust. But in general, such situations don’t happen overnight unless another black swan event occurs.
What You Don’t Know
We won’t blame investors for being unaware of these risks beforehand. In truth, there are many stalwart companies which continue to pay increasing dividends to investors routinely and without fail. Furthermore, some of these issues only surface after years of smooth operations.
Nevertheless readers should humbly accept that in the world of business, what you don’t know can really hurt you if you’re caught off-guard.
By understanding these pitfalls, we can avoid misdirection on the characteristics of such stocks, and evaluate dividend prospects carefully. Scanning for these issues beforehand can help preserve your precious capital and avoid potential losses and disappointment.