Dangerous to buy based on yield

When I mentioned that Capitaland Retail China’s 7.7% yield was attractive in my previous post, one reader rightly pointed out that it is “dangerous to buy based on yield”.

I cannot agree more.

I hope NONE of you will go away with this idea after reading my blog that we should only look at dividend yield to invest and nothing else. There are many great companies out there like Apple, Microsoft who are not having high dividend yield, YET if you have invested in them at a right price, you would have been rewarded very handsomely.

Dividend is Cash, Real & Concrete 😊

However, I feel we cannot deny that dividend is one concrete way of getting the return from your investments.

It is unlike share price that can simply go up and down based on investors’ sentiment, changing risk appetite, pure herd mentality and sometimes just from a few simple words by influential political and economic people. We have seen countless of such instances, especially so in USA lately.

dividend yield

On the other hand, I feel dividend can be relied steadily upon by investors as long as the business we bought into is strong, growing and profitable.

The only reason that a profitable company will choose not to declare dividend is because it has other avenues (like capital investment or repayment of high interest loan) to become even more profitable and cash rich in the future. So that … they can distribute more dividends in future. 😆

Dividends has to be paid from the earnings accumulated by the company over the years. Hence, even when a company is having a bad patch, it can still pay dividends to shareholders from its previous years earnings while it tries to overcome the current challenges.

Therefore, I feel dividend is more concrete and real than relying just on pure share price appreciation to obtain the returns from your investment. The latter leaves a lot exposed and too speculative for my liking.

Revision to Mean

As many of my regular readers will know, Reits made up a significant portion of my portfolio. When evaluating which Reits to invest, I place a lot of emphasis on the current yield.

One reason is because in the case of Reits, I believe in the reversion to mean theory for their yield.

I see it working over an extended period of time. Over the years, I have seen and trend dividend yields of Reits swinging from one end to another and then back again. If we have bought Reits at the higher end of the yield spectrum (i.e. low price), we will have a higher chance of reaping both high dividend yield and possibly appreciating share price when the market is on a bull run.

It is probably due to the fact that Reits is no more than a company that owns property and collects rents – it will go through the up and down of the property cycle which it will eventually return when demand increases or supply reduces when market equilibrates.

We just need to make sure that the Reits that we buy into (when dividend is high or share price is low) are well-managed, strong and have a defensible market share or competitive edge.

However, I can’t say this for other industries and companies. They earn their money differently. So my above belief is confined to Reits only.

Net Asset Value

I know of some friends who buy Reits that are at a huge discount to the Net Asset Value, hoping that one day the gap in the valuation will close either by the market or when a buyer acquired the company.

However, I am not a believer of this.

The reason being that the Net Asset Value of a property in a Reit depends on the earning potential of the property and not just on the value of the property itself.

A prime example is the recent disclosure by Sabana during its proposed divestment of its 1 Tuas Avenue 4 property for a sum of S$11 million, which is 52% below its book value of $23 million.

Interestingly, both valuation was done by the same company. Ahhh !!!!

It was quoted from Sabana’s press release that the earlier $23 million valuation was based on “capitalisation approach and discounted cash flow analysis method” (on 30 June 2018) while the latest valuation (done by the same company on 5 September 2018) of S$11 million was “using the comparison sales method”.

blood-day

OMG – it’s just 3 months and valuation is now halved

What a big difference the adoption of different valuation methods make … it just reaffirms my belief that net value asset declared by the company cannot be fully trusted and solely used for my investment decision.

A long post I know but bottomline – I still think dividend yield is important and especially in the case of Reits.

Happy to receive your feedback and comment on this.

Thanks and have a great week.

Regards,

Warriortan

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4 thoughts on “Dangerous to buy based on yield

  1. You are definitely an experienced investor from your blog sharing, there will always be different view from other experienced investor as well. Just ignore their harsh comment and focus on their different points of view.

    I do have some queries for reversion to mean method though, hope you can share your view:
    1) Do you identify the “mean” by using average value between high and low ? Formula = (High +Low) /2
    2) I seen you mentioned before you get the high and low yield from 3-5 years annual report. Have you consider to use 3 to 5 years quarter yield (TTM or annualised quarter div, by using quarter end/start price) ? In which you would have 12-20 yield data inputs instead of 3 to 5 yield data inputs.
    3) Assume you are considering of using 12-20 inputs as above mentioned, do u think using average value as “mean” will be a better way than (High +Low) /2 ? I’ve seen in some REIT which have certain high or low yield during particular period that would skew away “mean” if we use (High +Low) /2.

    Liked by 1 person

    1. Vince, thank you for your support. It is good to “hear” from you again.

      Good questions from you … let me try to provide some answers and if it is not clear, let me know and I will try again.

      Honestly, I could have done more to get a better “mean” using daily data but as a short cut, I have used the Reit’s DPU and the highest and lowest share price for the last 3-5 years to create a spectrum of operating yield for that same period. These info are available from the annual report

      So, I used a minimum of 6 to 10 points. Then using excel, I anchored the lowest yield as 0% (or in another word, 100% probability of having yield above this point) and the highest yield as 100% (it also means 0% probability of a yield higher than this point). Using the inputs, excel creates a best fit correlations through all these data. Then the excel would then return me a 50% probability point (or what I call a “mean” or P50).

      Depending on how the other points spread out between the 2 extremes, it may or may not be the average of the “lowest and highest points”. Take for example if there are more points closer to the highest yield and the lowest yield is an outlier, the P50/mean will be closer to the highest yield than a normal average.

      So the mean also takes into account the probability and track record over that few years.

      To create a safety margin, I will take the 66% probability point (NOT 50%/mean) as a buy trigger, which means that over that same period, the yield has a 66% probability to be higher.

      No one knows what the future if like, hence, through this approach, I feel it assures me a higher chance of getting a higher yield at the point when I buy the Reits.

      Hope it explains.

      Like

      1. I’ve been staying hidden reading around. Your explanation is very clear. I use slightly different way to collect inputs than yours.
        For CRCT, I took 5 years quarter div divided by quarter end price and annualised it, total 20 inputs. Will get highest 8%, lowest 5.78%, average 6.64%, current ttm yield 7.24%. Convert average to price would be $ 1.531 (P50 in your case)

        Done the same for P/NAV range, highest 1.053, lowest 0.869, average 0.947, current 0.892. Convert average to price would be $ 1.486 (P50 in your case)

        I do also take average percentile 5 years quarter end price range and apply it with on 52 weeks price range, which you would get 1.509 (again P50 in your case)

        Liked by 1 person

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