Getting paid while you wait

Buying high dividend paying stocks trading at deep discounts to
their asset values can be a viable strategy

Getting paid while you wait

Show me the Money
21 Jan 2012
By Teh Hooi Ling
Senior correspondent

IN a chat with Benny Ong, founding director of Life Planning
Associates, in October last year, he shared his strategy of buying
high dividend paying stocks which are trading at deep discounts to
their asset values. It’s a strategy that pays you while you wait, so
to speak.

In October last year, the market was still very much weighed
down by uncertainties over the eurozone crisis. So Mr Ong’s
message was: there continues to be opportunities out there
despite the very poor market sentiment. “You can buy now if you
can hold. I’m not too concerned about the crisis in Europe and the
US,” he said. “The worries in China will not last long.”

Companies with under-appreciated value will sooner or later be
recognised, either via privatisation or when the market turns
around. The risk in the case of a privatisation, of course, is that
investors might continue to be slighted with a low offer price.

That risk notwithstanding, investors should take note of a few
things for this strategy to work. First, ascertain that the assets of
the company have been valued fairly and realistically. Second, it is
good if these deep value stocks are also paying decent dividends.

“Three-quarters of such companies you have in your portfolio must
pay you dividends. You don’t know when they are going to be
privatised,” said Mr Ong.

Third, make sure that these companies have little borrowings.
Since then, I’ve been wondering what kind of performance an
investor would get if he or she were to pick a basket of stocks
with high dividend yields, but low price-to-book ratios.

So this week, I decided to test out the strategy. I downloaded the
list of stocks trading on Singapore Exchange every year on March
31, starting from 1990.

Included in the data is the dividend yield of each stock, its price-
to-book ratio (that is its share price relative to the historical cost
after depreciation of its assets), and its last traded stock price of
the day.

I ranked the stocks based on the ratio of their dividend yield over
the price-to-book (PTB) ratio. So if the dividend yield is 4 per cent
and the PTB is 2 times, then the number I get is 2.

Stocks are ranked based on that number, from the highest to the
lowest. They are then divided into 10 groups of equal number of
stocks. Decile 1 would be stocks with the lowest dividend yield but
the highest PTB ratios, and Decile 10 are stocks with the highest
dividend yield, and the lowest PTB. No screening was done on the
quality of the assets and the debt levels of these companies.

So each year, there will be 10 groups of stocks. I then tracked the
returns of the stocks in these 10 groups a year later. I used the
median price appreciation to represent the return of that group. I
also added in the median dividend yield to calculate the total return
for that group of stocks.

Each year, the groups of stocks will be
different depending on their dividend yield and PTB as at March
31. Let’s assume that 10 investors started 1990 with $100.
Investor 1 will always invest in Decile 1 portfolio, and Investor 10
in Decile 10.

At the end of the first year, each investor’s portfolio would be the
median return of the stocks in each decile, plus the median
dividend.

The amount of money at the end of the first year will then be
reinvested into the second groups of stocks in the various deciles
in the second year.

http://www.btinvest.com.sg/system/assets/1365/paid1.jpg

The process goes on for 22 years, from 1990 till Jan 17, 2012.

How did the strategy do?

As you can see from Chart 1, buying stocks with the highest
dividend yield, but lowest PTB ratio appears to be a winning
strategy. Following that strategy over 22 years would turn $100
into $1,575. That’s a compounded annual return of 13.3 per cent a
year. This group of stocks are relatively resilient during downturns,
supported by the dividend yields.

In comparison, stocks with the low dividends and high PTB fared
miserably. The $100 invested in Decile 1 would have diminished to
just $16. That’s a decline of 7.9 per cent a year. Meanwhile, the
Straits Times Index’s capital appreciation over that period was 3
per cent a year. That figure excludes dividends.

http://www.btinvest.com.sg/system/assets/1366/paid2.jpg

Chart 2 shows the performance of the Decile 10 portfolio vis-a-vis
the movement of Straits Times Index. As you can see, the declines
in the Decile 10 portfolios during bear markets were not as sharp
as that of the index.

http://www.btinvest.com.sg/system/assets/1367/paid3.jpg

Finally, Chart 3 shows the compounded annual returns of the
various deciles over the 22 year period. Other than Deciles 8, 9
and 10, the others are all money losing propositions.

All the above calculations do not take into consideration
transaction costs. But it does show that in general, buying into
stocks which pay high dividends but are priced cheaply relative to
their assets is a viable strategy.

Readers who are interested in knowing the list of Singapore
stocks which fit these criteria can now find them in the Monday
issue of The Business Times.

In the coming columns, I will generate the returns for baskets of
stocks based purely on say, their PTB, or dividend yield, or price-
earnings ratio. We will then see which strategy works the best.

Until then, I’d like to wish all readers a healthy and prosperous
year of the Dragon.

The writer is a CFA charterholder
hooiling@sph.com.sg

Link:
http://www.btinvest.com.sg/markets/stocks/getting-paid-while-you-wait/