Divided by Dividends?

Published on 14th February 2006

(Unlike in the U.S. and many other countries, tax dividends in the Kenyan market are deducted at source thus not taxed after issue.  This has a positive impact on the overall return)

I recently had an opportunity to share in the joy of a woman who after buying share portfolio of three companies over a decade ago kept on hold for a period of time.  Her faith and optimism had been ignited by her broker who told her that the company whose shares she owned would send her a check at the end of every year.  “Its money I haven’t worked for after all!” She said. The broker was right, but how reliable would such information be today in the investor savvy world where unlike a few decades ago, people do not look at how much a company issues as dividends but more sustaining reasons. Such reasons among others would include the existing management, expansion plans, new products, changing regulations within an industry and corporate sponsorship. 

The savvy investor today doesn’t care much about when a company is likely to close its books and the subsequent issuance of dividends.  It matters most that the company is in good hands and a capable Chief Executive whose publicity will see the stock rise by a shilling a day.  Consider Mumias Sugar Company (MSC) for example, towards the close of the books in 2004, the share was trading at Kshs.33.  Just after the close of its books, the share price dropped to Kshs.30. This period was marked by higher trades as investors who were driven by the good results purchased the stock.  For the dividend earners, the dividends might have offered the needed results after which it was no longer required.  Going by the fundamental recommendations would have served best.  This is true because the valuation done by African Alliance valued it at Kshs.23.  A month ago, MSC surpassed everybody’s expectations to trade at an average of Kshs.41.  This has left me asking, why should someone dwell so much on dividends, retaining stocks for a given period of time while he/she can short sell or hold long enough to make a considerable return?  Dividends, by all means, should not be drivers for getting in the stock ownership, or at least, actively trading in the stock market.

Buying a stock for the sole aim of getting dividends is a strategy called income investing. Traders who invest for this reason will tend to be attracted to non growth companies that have reached a certain growth level. Such companies are usually in less expanding industries.  Their high dividend payout is justified by the fact that other than building on their retained earnings, they pay out the money as dividends because they have already reached an anticipated growth level.

Investors eyeing dividends will most likely look at the dividend yield (which is what you get when you divide annual dividend per share by the share price).  This tells an investor how much to expect in dividends of the shares owned.

Whereas the average dividend for companies would be between 2-3%, dividend investors will look for companies with a dividend yield of at least 5%.

It is most important that investors consider a company’s dividend policy. They must carefully analyze its decision to increase its dividends by whatever amount.  If say a company decides to increase its dividend from 2% to 5% within a short period (say 1-2 years), this may be too ambitious and may not be very sustaining in the long term.  A company that has a long history of paying good dividends is likely to maintain this trend in the long run.  An example is Barclays Bank, Unilever Tea, Standard Chartered Bank, Limuru Tea and British American Tobacco.

The truth is; one should not just look at dividends (income investing) as the sole reason to invest.  They should keep in mind that dividends will not generally indicate a good company because they are paid out of a company’s net income that could otherwise have been channeled to retained earnings thus re-invested.  If one has to invest solely for earning dividends, he has to do an extensive study to only go for companies that are rated highly. Income investing has one great advantage because dividends are not usually taxed after issue.  This is unlike in the United States where the government is still trying to fight to drop off the tax that may have shunned many willing investors.  One disadvantage is that this tax reduces one’s earnings by a margin, almost like your wage.  

Higher dividends do not always imply lower risk; this is because companies that have a higher dividend may be susceptible to a higher risk than smaller companies.  Take Kenya Airways whose dividend per share was at Kshs.1.25, for example. This again may not translate to the company’s growth potential and share price, which has grown from Kshs.12 to Kshs.92 within a period of less than two years. 

What should one therefore look for?  It is not the information that your broker will give you. Over-relying on ones broker overcomplicates the whole investing game making stock picking too complicated. One should study the financials as often as possible, read recommendations from independent writers (they have an unbiased, fundamental, and external view) who are less driven by emotions that rate highly at the stock market.

The bottom line is; using dividends as a basis for picking stocks is not the right approach. It is more crucial to follow the fundamental analysis as it encompasses more discrete bases for a stock recommendation. 

For queries in relation to the Kenyan stock market; e-mail me at m_musau@yahoo.com/mmusau@k-repbank.com and your queries will be published in the next issue of the African Executive.

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