Ideally, as investors, we should first assess a stock’s fundamentals before investing. Such would include understanding its business model, financial results and growth plans. However, as we all have busy schedules and would prefer our time to be spent on other activities: work, health, and family, we may use screeners to sift through thousands of stocks to find a dozen few that meet a list of criteria, which may fulfill our “wants” for a stock.
These screeners can either be free or premium.
One of the many criterias that can be set is on our preferred dividend yield.
So, let’s assume that you are busy and looking for stocks that pay above 5% in dividend yields a year. You used a screener and found “A Bhd” to be paying 7.5% in dividend yield. Since A Bhd’s dividend yield fulfills your criteria, should we conveniently skip the process of evaluating A Bhd’s business fundamentals and just invest in its shares?
Source: Google Finance
The answer is no.
First, we need to understand the context of the 7.5% dividend yield. Such is calculated based on A Bhd’s latest 12-month dividends per share (DPS) of 18 sen and its current stock price which is RM 2.80.
Current Dividend Yield
= Latest 12-month DPS / Current Stock Price x 100%
= RM 0.18 / RM 2.80 x 100%
= 7.5%
Does it mean that if you invest in A Bhd, you’ll receive 7.5% dividend yields per annum for years to come?
The answer is not necessary.
We need to look at the source of dividends.
Dividends are paid from earnings.
Earnings are what’s left after subtracting business expenses and taxes from revenues.
A Bhd could only sustain 7.5% in dividend yields per annum, if it can generate consistent growth in revenues and earnings over time. Otherwise, it is not sustainable. As investors, the study of A Bhd’s fundamentals is just not about calculating the quantum of dividends, but also assessing its consistency in its dividend payouts.
Here are A Bhd’s revenue and earnings figures for 20 years from 2004-2023:
Its revenues seemed okay but not its earnings. After delivering RM 110-130 million in earnings a year in 2010-2013, A Bhd’s earnings had declined over time. The question is: “Is A Bhd a stock I could trust to keep paying out 7.5% dividend yields per annum?”.
For me, nope.
Once again, it is not about dividend yields but the consistency of it.
Now, consider another stock – B Bhd.
B Bhd could offer 4.6% yearly dividend yields. It’s below your “5% dividend yield” criteria and the stock would not appear in your list after using a screener. However, if you trace its financials, the amount of earnings B Bhd had delivered looks like this:
Fundamentally speaking, B Bhd is far more superior than A Bhd for B Bhd has a superior record in delivering consistent growth in profits to shareholders.
B Bhd could be trusted to deliver its 4.6% dividend yields as its earnings figures are growing. As such, although 4.6%, B Bhd is more valuable an investment as compared to A Bhd.
This is why a stock’s fundamentals are prioritised over its valuation (including dividend yields).
Hence, it is better to follow these steps:
Step 1: Fundamentals
Step 2: Valuation (PE and dividend yields)
And not:
Step 1: Valuation (PE and dividend yields)
Step 2: Fundamentals
For those of you, who intend to learn how to build a Dividend-based Portfolio or a Growth-based Portfolio, once again, it is a matter of suitability between the educator and yourself. Below would be the links to free webinars so that you can check us out and assess if we’re the right fit for you personally.
Dividend Investing:
Free Webinar: How to Build a Stock Portfolio that Pay Increasing Dividends?
Growth Investing:
Online Training: Case Study of 1 Actual Stock that I had Invested in and Why It Doesn’t Take High Risk to Generate High Returns in the Stock Market?
