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As global financial markets become increasingly turbulent and interest rates start backpedalling from the slowing economy, investors chasing yields have fewer alternatives.
Stuck between a rock and a hard place, one approach to navigate this uncertainty and recession fears is through dividend investing – which helps investors stay sane from stock price volatility thanks to stable income-generating assets.
Dividend investing is a generic term that means investing in companies that pay dividends, and these cash payments – a type of shareholder returns – form part of your passive income.
These payments can be quarterly, semi-annually or annually, depending on the company’s dividend policy, thus forming a reliable bedrock of passive cash flow if you can accrue enough shares.
There are several popular ways you can construct a portfolio as part of dividend investing, and not all are created equal. Companies that have shown sustained dividend growth are well supported in challenging market conditions.
In this post, I’d like to talk a little more about three dividend strategies for retail investors –
- High yielding dividend stocks
- Dividend appreciation stocks
- Real Estate Investment Trusts (REITs)
Let’s explore each one of them in more detail.
High Yielding Dividend Stocks
High yielding dividend stocks are stocks which pay a higher than average dividend yield. To obtain the dividend yield of the stock, you divide the dividend per share by the share price.
These high yielding dividend stocks are an attractive way for investors looking for passive income – for example, retirees who are looking to fund their retirement lifestyle or investors looking to generate cash flow into their bank accounts while they sit back and relax.
There are several reasons why these companies are paying high dividends – they could have a strong and stable business model that generates sustained profitability, potentially undervalued stocks, or it could be because the stock price has fallen considerably as a result of weakening sales and lower future growth prospects.
Not all high yielding dividend stocks are good.
For example, if we look at StarHub (CC3), at today’s price their trailing twelve months (TTM) dividend yield is 9.47%, and 12% last year, far higher than the STI’s TTM dividend yield of 3.8%.
Is Starhub a buy at today’s price and dividend yield?
We don’t know, but it is certain that investors are not optimistic about the prospects of the company, and future dividends are likely to be cut as the dividend policy is not sustainable.
In addition to dividend yield, there are several other metrics used to evaluate a high dividend-paying stock. The dividend payout ratio shows how much of earnings is paid out as dividend (and corresponding, how much is reinvested into the business).
Companies with high dividend payout ratios tend to be mature and do not reinvest much of it back into the business, limiting growth prospects and future earnings.
The dividend growth rate is also another good metric to track, it measures the annualised percentage rate of growth in a company’s dividends – useful in pricing stocks as in the dividend discount model.
As dividend growth can be both positive and negative year on year, the annualised percentage rate gives investors a better view of dividend growth performance.
Of course, all these factors must be considered in combination, alongside other fundamentals like business opportunities, earnings growth, sustained competitive advantage and macroeconomic risks.
One way to invest in a pool of high yielding dividend-paying companies is through an ETF like the Vanguard High Dividend Yield ETF (VYM) – which tracks more than 400 highest yielding stocks on the market – may or may not be the best option.
The good thing is that investing through an ETF gives you broad ownership in many high dividend-paying companies weighted by market cap in the case of VYM. You get significant exposure to the largest companies globally like J&J, J.P. Morgan and Cisco Systems at an expense ratio of just 0.08% annually.
However, such heavy exposure to giant U.S. based companies at a mere ~100 basis points of dividend yield advantage over the S&P 500 might not be the best option for younger investors, who can (and arguably should) take more risk in their investment approach on faster-growing companies which yield a higher total return, especially with low interest rates supporting growth.
Dividend Appreciation Stocks
Dividend appreciation stocks take a different approach. In this case, the strategy involves looking for stocks which have shown an increasing trend in dividend pay-outs, a strategy also known as dividend growth investing.
Dividend growth investing does not promise high dividend yields, but instead, it identifies good quality companies which have a history of consecutively increasing or maintaining dividends – a sign of strength and management prowess.
One reason why dividend growth investing is popular is because nobody wants to invest in companies which pay a huge dividend in one year and then pay half of it the next, a quarter of it the following year and the nothing at all once it goes bankrupt. *cough, hyflux, cough*
Dividend growth investing ensures that you identify solid companies which;
- perform consistently well,
- have stable business models and,
- increasing cashflows.
All of these factors ensure that your dividends are growing every year – even if you just sit idly and do nothing about them.
Real Estate Investment Trusts (REITs)
REITs are an attractive way to purchase a portfolio of stable income-generating property assets which provide regular income distribution from rents.
These are professionally managed trusts that invest in real estate and manage the tenants and operations of the properties in the portfolio.
The attractiveness of REITs can be seen from their higher than average dividend yields – typically ranging from 4% to 10% – compared to the broad market index, thanks to their clever use of leverage to borrow and fund property purchases.
In addition to dividend income, REITs can also appreciate in value and have price appreciation as well – benefiting long-term investors who can ride out the uncertainty in the markets.
Check out: How to Invest in REITs Singapore 2019
Now that you’ve understood the basics of the different form of dividend investing, how do you execute it by constructing a portfolio?
My preferred way – if you’re a novice investor or lack the time to do investment research – is to just buy an ETF of your preferred strategy.
For example, for an Asian based portfolio of high dividend yielding ETF, Vanguard also has an Asia Ex-Japan High Dividend Yield ETF (9085) that pays an TTM dividend yield of 3.62%, invests in 392 companies weighted heavily towards financials (40%) and technology (16.5%) at an annual expense ratio of 0.35%.
Comparing the Vanguard Asia ex Japan High Dividend Yield index (in Green) against the Vanguard Asia ex Japan index (in Blue) shows how they both trend rather similarly, but the High Dividend yield ETF has lower 1-year volatility (13.31%) compared to the standard index (14.61%)
For REIT investors who are lazy, the Nikko Asset Management-STC Asia REIT ETF invests in a portfolio of Asia ex-Japan REITs with distributions paid quarterly at a total expense ratio of 0.60%. Asia ex-Japan REITs yield one of the highest dividends in the world, and Asia’s economies (and correspondingly property values) are expected to continue growing with the rising middle class.
Dividend Investing is Just One Form of Investing
While dividend investing has its perks from steady cash-generating assets or stable and profitable businesses (‘blue chips’), dividend returns are just one half of the total return equation.
Capital appreciation, or the percentage change of the current price versus the price a year ago, forms the other side of the return equation.
Investors looking for capital appreciation are typically called growth investors, and they chase earnings growth and higher future dividends rather than present-day income.
There is no one size fits all in investment approach and the right strategy has to be tailored to your risk appetite, cash flow needs and investment horizon.
For me, watching the regular cash flows from dividend-paying companies coming into my bank account during times of distress and market turbulence helps me stay the course and take a long-term approach to investing in the stock markets.
Our Early Retirement Masterclass is taught by Chris Ng, who’s passive income from dividends in the stock market exceeded his liviing expenses at 32. He went on to make his first million in stocks by the time he was 37. All of this was through dividends based investing strategies. He clocked a passive income of $9,500 per month in 2018 and looks to be on track for more by end of 2019. If you’re keen to find out how he did all of that, you can register for a seat here.