Contributed by Warriortan, #investforyourself
In a recent workshop, I came across this theory of applying the concept of “Reversion To Mean” to equity investments. I felt that it made logical senses and since then, I have added this as an additional tool to my toolbox to investing.
So what is “Revision-to-mean” concept?
According to Investopedia, “Reversion to Mean” is the theory that suggests that prices and returns will eventually move back toward the mean or average. This mean or average can be the historical average of the price or return, or another relevant average such as the growth in the economy or the average return of an industry.
How do I apply it?
I only apply it to Reit and using “dividend yield” as the single parameter to track.
By applying “Reversion to Mean”, conceptually I am believing that the dividend yield of a particular Reit will eventually move back towards the mean dividend yield given time. There are always new situations or changing investor sentiments that will move the share prices of Reits towards the extremes either low or too high irrationally. But once things cool down, things will go to normal and the share prices will adjust back to the mean dividend yield. Those “extreme” moments are actually the best time to buy or sell. Hence, “Revision-To-Mean” becomes a way that will trigger me to think about whether the share price is at a oversold or a overbrought region and thus, should I take action to buy or sell respectively.
Some of you may ask why use dividend yield and not not share price. I know some people pay a lot of attention to the 52 weeks high or low and may base their buy/sell decision on that. However, in my opinion, share price itself is not an indication of the return to investors. Dividend yield is and definitely so for a Reit investment.
Furthermore, I believe dividend yield is an indicator of the level of risk that the investors are willing to take with a particular company. Hence, unless there is a structural change in its business, management or strategy, the dividend yield that the investors will demand from the company will not and should not change drastically.
What do I to apply it?
First, I researched for the historical dividend yield of the Reit for the last 3-5 years to determine the upper and lower brackets of the Reit’s dividend yield. Then, I will track the share price of the Reit to calculate the current dividend yield weekly to see where it is located as a percentage between the upper and lower brackets. I will update the upper and lower brackets once a year using the annual report.
Let me share the table I have made for the Reits that I am currently tracking to illustrate how it is done:
(Data updated to 29/4/2017)
|Share Price ($)||Annual DPU (cents)||Current Dividend Yield (%)||Highest Yield (%)||Lowest Yield (%)||Current Percentile|
|VIVA ind Trust||0.82||7.17||8.80%||10.40%||8.30%||24%|
How do I interpret this?
Let us take the example of Ascendas Reit.
- As of last Friday, it closed at $2.56 per share.
- The trailing dividend per unit is 15.97 cents and therefore, its current dividend yield is 6.24%.
- This current dividend yield will depend on the share price which I tracked every week. The DPU is updated quarterly when the result is out.
- The highest and lowest yield is dependent on the historical information for the last 3-5 years.
- The current percentile is to show where the current yield sits between the highest and lowest dividend yield points.
- In this, the current yield is 6.24%, it is at the 50th % point between 7.5% to 5.0% range.
- If the percentile is closer to 100%, it means that the share price may have been “beaten” down to a low point that I will consider accumulating while if the percentile is closer to 0%, it means that the share price may have risen to a lofty level that may not be sustainable and then, I may consider selling.
- Sometimes, it is not the price that has changed but rather the dividend yield has improved or gotten worse. In either cases, it will warrant me to have a closer look and re-evaluate my investment approach to that particular Reit.
- In my case, the trigger points are 75% and 25%. I don’t wait until it is 100% and 0%.
What are the decisions that I have made recently based on this?
- I had sold my small position in Viva Industrial Trust completely, especially when I heard the news that they have issues with the Master tenant at Jackson Place who is providing income support.
- I have been accumulating Ascendas Reit, CapitaMall Trust, Fraser Commercial and SPH Reit earlier. Their percentiles have recovered closer to 50% now. So I will now wait and see how things develop from here. See my previous post on SPH Reit
- I am planning to reduce my holding in Ascott Reit : see my previous post on Ascott Reit
- I am planning to take profit on First Reit and Capitaland China Retail Trust.
In a nutshell,
I find this a useful way to trigger me to re-evaluate my investment approach to a particular Reit.
I have to state that this is ONLY one of the tools that I used. Fundamentally, we still needs to understand fully the business of the companies we invested, their strategy and management strengths, and delivery of performance. We need to know if things have changed that may make the upper and lower range of the dividend yield invalid.
I hope you find this useful and may consider this as a tool in your investment toolbox.
Have a great week ahead.