Issue 178, 22 June 2005
Investor's College Ducking dodgy dividends The juicy-looking yields you see in the newspaper aren't always what they seem. Last issue we discussed some important questions to ask yourself before buying a stock on the basis of its dividend yield. This time we’re going to focus on applying those lessons in a practical sense. To do this, we’ve taken a selection of stocks, together with their published dividend yields, and we’ll take a look to see how they stack up on closer inspection. The stocks we’ve chosen are listed in the accompanying table. We’ll assume, for starters, that you took our pledge in the last issue and are only considering stocks that you understand. The second point, then, concerns whether a stock is in a particularly cyclical industry. If that’s the case, then its yield may be deceiving during boom times. Residential construction makes for a good example. Several of the stocks listed in our table— AV Jennings, Central Equity , Crane Group and Kresta — are significantly affected by this sector of the economy. On 12 May, after revealing a 60% slump in profit for the year to 31 March, the management of AV Jennings (Australia’s largest homebuilder) highlighted that the sector is in a ‘cyclical downturn’, which has been ‘occurring for about one year’. Management believes it can maintain or grow the company’s 11 cent fully franked dividend but, by pricing the stock on a fully franked yield of 7.5%, investors would appear to be sceptical about this (the negative operating cash flow and rising debt don’t engender a great deal of confidence). The next question to ask is whether a dividend is reliant on a low-quality business. Into this category we’d place paint manufacturer Wattyl, metal recycler Sims Group, appliance manufacturing group GUD and automotive and finance concern CMI (looking over those names, it’s clear that most happen to be quite cyclical as well as being low quality). No cash paid out We got pretty heated about the topic of ‘faux dividends’ last issue. And Crane Group’s latest interim dividend is a classic example. With a fully underwritten dividend reinvestment plan, any money actually paid out to shareholders will be offset by an equivalent issue of new shares to the underwriter. So, on a net basis, the company hasn’t actually paid out any cash— although the charade will have cost some money as the underwriter will presumably have been paid a fee. The final point concerns listed investment companies, which will often pay out extra dividends when times have been good, thereby flattering their yield. This is the case with both Platinum Capital and Wallace Absolute Return Fund. While we have a great deal of admiration for the team at Platinum, we’ve expressed reservations about this stock’s price in recent years. As for Wallace, the selective reporting we highlight on page 3 provides one indication as to why we haven’t recommended it to subscribers. So what’s left? Well, we currently rate David Jones a Hold for Yield, HPAL a Long Term Buy and Infomedia a Buy. Unfortunately none of them offer absolutely eye-popping yields at the moment but that leads us to a key point. How would you like to buy a blue-chip share with an impressive track record of growth and good prospects on a dividend yield of 7.9%? What if we told you that you had to buy the stock now on a yield of 4.6% but that it would grow to the 7.9% (and then higher) in two and a half years? Well that’s exactly what happened to our investment in Macquarie Bank after we upgraded it to our second-ever Strong Buy recommendation in issue 114/Oct 02 (Strong Buy— $20.39). And the situation with our inaugural Strong Buy, FKP, was even more dramatic. When we first recommended it in issue 84/Jul 01 (Strong Buy— $0.81), it had just slashed its interim dividend by 80% to a measly 1 cent per share. By the time we recommended a full sale in issue 126/May 03 (Sell— $1.76), the company was set to pay 12 cents in fully franked dividends for the
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year, which equated to a yield of 14.8% on our purchase price. We’ve seen the opposite to this at Schaffer, which recently announced that dividends would be cut after September this year, and we believe similar announcements are highly likely to be forthcoming from companies such as Sims Group and CMI over the next few years. In each case, the historical dividend yield looks attractive, but the return over the next few years is likely to be lower. That’s also the case for Infomedia, which recently cut its interim dividend back by 10% to 1.7 cents per share (often an ominous sign), although we believe the company’s business is strong enough to sustain an attractive level of dividends over the longer term. It is here that the science and art of investing intersect. Calculating historical dividend yields is a science, but projecting a business’s future performance and dividends is much more of an art. We hope this two-part series will help you avoid some of the pitfalls that await the inexperienced and unwary.
C o p y r i g h t © 2 0 0 6 The Intelligent Investor . Published by The Intelligent Investor Publishing Pty Ltd. ABN 12 108 915 233. Australian Financial Services Number 282288. PO Box 1158, Bondi Junction NSW 1355. Ph: 1800 620 414 Fax: (02) 9387 8674 WARNING This publication is general information only, which means it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether a particular recommendation is appropriate for your needs before acting on it, seeking advice from a financial adviser or stockbroker if necessary. Not all investments are appropriate for all subscribers.
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So what’s left? Well, we currently rate David Jones a Hold for Yield, HPAL a Long Term Buy and Infomedia a Buy. Unfortunately none of them o...