Saturday, May 26, 2007

Investment Mistakes Part 1 - Buying purely for dividend

Dear readers, this is the first of a series of write-ups regardig my investment mistakes which I had mentioned before that I would talk about. The importance of maintaining an investment journal to catalogue all mistakes and lessons learnt had already been blogged about by myself in a previous post. Now, I will attempt to go into detail on th various mistakes and how value investors should keep a clear, rational mind when going about the investment process. Also, I had just gone for a Europe Trip briefing today and am pleased to confirm that my honeymoon will officially begin on June 6 (midnight) till June 17 (early morning touchdown). During this time, I will NOT be blogging at all (obviously !) and will also be totally "out of the market". I will give all readers another reminder again when the time comes.

OK so let's begin. The first mistake I wish to talk about is to buy a company purely for dividend. First, I would like to say that if you are above 50, have very low tolerance for risk or have more than enough spare cash; then by all means this may be the right method for you. However, I am coming from the perspective that younger people would wish to purchase a company in order to extract more capital gains from it, rather than dividends. This is because dividends cannot be guaranteed (it depends on the cash flows and health of the company) and the so-called dividend yield may even be offset by capital loss; thus making it a bad investment.

The example which I quote is a real-life one which happened to myself back in Feb 2005 (when I first began investing). I had purchased MCL Land Limited due to a massive dividend declared of 68 cents per share (gross). After the XD, the price fell from my purchase price of $1.97 to $1.37, which was greater than the net dividend of 54 cents per share (at 20% tax rate) from this company. I sold it at a loss of about 3% from my total investment cost, which can be considered small but the lesson to learn here is that one should not buy purely because a large dividend has been declared. Sometimes, it is more important to dissect the company to see if it has growth prospects. Otherwise, you may just sit on your butt collecting dividend all your life while the stock price languishes (this does not apply to REITS which are good for stable income). For avoidance of doubt, I emphasize that this approach is for people who are going for growth or value companies in order to enjoy multt-bagger capital gains in 5-10 years.

Thus, dividend should be seen as a bonus rather than a requirement for investing in a company. I have often heard my friends mentioning how good it is to buy X company because they just declared a large dividend. To provide a counter-argument, companies which declare large dividends may not be good because they have nothing better to do with the cash ! Thus, they are returning it back to shareholders instead of using it to grow the business and to produce superior returns. Each company should be evaluated based on its merits, but in general, companies who propose large dividends or capital distribution have no other uses for their cash, which is why they are returning it back to shareholders. As a good example, I was pleased that Ezra Holdings Limited, in its April 9 GY 2007 results announcement, did not declare a cash dividend but instead proposed a bonus share dividend. This would help it to conserve cash yet expand its capital base to provide better trading liquidity and affordability for its shares.

The REIT I am holding now (Suntec REIT) is purely for dividend and I have no growth expectations for this REIT. Thus, I can safely say my 5 other companies are purchased for their growth prospects; dividends will be a good bonus.

Pacific Andes Holdings Limited - OCBC research head Carmen Lee's Stock Picks

On a side note, in today's The Edge Singapore publication, Pacific Andes was featured as one of Carmen Lee's stock picks for growth and value stocks. There was a glaring typo which said that PAH owns 63.9% of China Fishery; but the acquisition is essentially not complete yet ! In fact, only the CB has been issued, but the rights issue is still subject to shareholder approval and an EGM needs to be convened. The report is misleading as it assumes everything has already been finalized; it is also too short a write-up as it does not talk about China Fishery's recent purchases of up to 7 purse seine vessels for increased fishmeal holding volume and catch volume. OCBC's target price is $1.41, which I feel is kind of plucked from the air since PAH's FY 2007 results are not even out yet. Judging by the way the business is growing, I am hoping for better margins and better valuations in time to come.


Berkshire said...

Hi Musicwhiz,

Congrats on your wedding and a blissful one.

Do you have any comments on the current SG market? I was actually glancing thru the whole of the SGX and I found nothing except one or two counters which I may still consider as potentially undervalued. One obvious counter is Lion Asia Pac although its earnings is not as fantistically great or even good for the matter but it is the traditionally Ben's kind of selection where the whole biz is available much less than its liquidable value. The other I may consider is if QAF drops by another 6 to 10%, although it should still reasonably higher in a year time than today.

musicwhiz said...

Hi berkshire,

Thanks, I certainly hope I will enjoy my honeymoon as it is my time to unwind after working my butt off for so long haha !

The current SG market is still going strong, but I agree there are few under-valued companies left. For Lion Asia Pac, I will have to take a look at it before I can comment. For QAF, never really thought of it as a good buy haha. Some friends did ask me to research on China Energy and Asia Power which I will commence on soon. Also, The Edge has mentioned Hiap Seng Engineering which is worth a look. I also wish to look at Ferrochina to see if there are further growth prospects. Thus, quite a bit of serious research to do.

Shingo T said...

Congrats on ur wedding and honeymoon too. ^_^

I'm going Europe for honeymoon in Sept 07, just a few months after your trip.

Keep up the great work - a good read for stocks layman like me.


musicwhiz said...

Hi shingo t,

Thanks, I do appreciate the support of people like you who regularly visit my blog to read up more on value investing. I think the difference between my blog and most other investing blogs is that I type out every single word (not copied and pasted). Thus, there is a personal touch to it. I have opinions for many aspects of investing, the economy and the market and I will gladly share them with the rest of the world.

Cheers and wishing you a happy and enjoyable honeymoon too !

Anonymous said...

hi bro...congrats and best wishes on your wedding..happy honeymooning!!!

best regards

yyt said...

Hi MW,

was reading your past post and I must say you write really well, very coherent. :)

Was wondering if you still rank cap gains over dividends, or have your perspective changed in recent years?

Musicwhiz said...

Hi Rocman,

Guess this is way belated, but thanks for your congratulations haha!


Musicwhiz said...

Hi yyt,

Thanks, really appreciate your compliment and the fact that you are trawling through my older posts, haha!

I rank dividends as being a stable source of income, while capital gains are expected to be steady and move along with the growth of the business.

So I guess I place more weightage now on dividends, and of course the certainty that the business an grow and continue to produce FCF.