A goal many of those in the “financial independence, retire early” movement strive for is to have a stock portfolio just churning out dividends that can be lived off, leaving the drudgery of day jobs behind.
This is not an easy goal, and such a cash-spewing machine can‘t be set up quickly. But it has been done.
With the benefit of hindsight, investors who backed the best and most enduring of the small-cap listings of the so-called Class of 1987 — Bowler Metcalf, Spur, Transpaco, Nu-World and Combined Motor Holdings — with a R100,000 investment would now be coining a fair annual annuity.
Early investors in the old PSG Group — when the share ranged between 30c and 150c in the mid-1990s — not only scored astounding capital gains but got regular dividend flows that covered the original investment many times over.
With some contrarian timing, it is possible, though not without assuming considerable risk, to quickly lock in a lucrative yield. Dangerous dividend delving is not for the faint-hearted. But those who were brave enough to back some of the Covid-racked stocks, such as gaming giant Sun International and Spur, have got most of their investment back in dividends and are enjoying a mind-boggling yield on their original investment. Others were less fortunate. Remember airline Comair, an excellent business that booked consistent profits and dividends for half a century until it was permanently grounded by the pandemic?
Investors can also be let down by the most dependable blue chips. Shareholders in mining conglomerate Anglo American were shocked out of their socks when the final dividend was cut in early 2009. Remgro’s late, great CEO Thys Visser always defended the investment company’s habit of hoarding cash, arguing that the cash pile was an effective insurance policy for dividend payments through leaner times.
These are weighty matters for retirees looking to supplement their pension. A retiree needs a steady stream of dividend income from their retirement nest egg to cover day-to-day living expenses.
So you’d think the Satrix Divi Plus ETF would be a popular choice; on paper it fits the bill. But it’s worth taking a bit of a deeper dive before hitting the buy button.
First, consider the yield on the Satrix Divi Plus, now at a steady 5.41%. This seems pretty decent, considering that most people are working on drawing down 4% of their capital to cover annual living expenses. With a slightly higher dividend yield, you get the required yield with some to spare. Or you can invest less of your capital upfront to achieve the same desired yearly income due to the higher yield.
Another point to consider about the Satrix Divi Plus is that it invests only in South African equities listed on the JSE, so dividends are paid out in rand. This means that you won’t have to worry about currency translation of the dividend payments. People in retirement want more certainty, not more surprises. If your living expenses are all in rand, it makes sense to get all your dividends in rand as well, which removes the foreign exchange risk.
For the record, there is a considerable rand hedge element to the Satrix Divi Plus portfolio. The latest fact sheet shows top holdings in global financial services counters Investec (7.25% of the portfolio) and Ninety One (3.63%), along with British American Tobacco (6.83%). Then there are the hard currency-earning commodity counters such as Exxaro (6.79%), African Rainbow Minerals (4.83%), Sibanye-Stillwater (4.01%) and Sasol (3.63%). Old Mutual (4.96%), consumer brands conglomerate AVI (3.72%) and Absa (4.12%) make up the rest of the portfolio’s top 10 holdings.
It’s convenient receiving South African dividends through the ETF, as it means the 20% dividend withholding tax is deducted at source, and no further income tax is liable once in the investor’s hands. This can be a powerful tax strategy if you know your marginal tax rate is going to be higher than 20% in retirement, as it can lower your overall marginal tax rate.
As the dividend withholding tax is deducted at source and paid to the South African Revenue Service, there’s no need for additional budgeting for tax payments when filing provisional or annual tax returns in retirement. So it makes for a cleaner, more straightforward tax return process as opposed to getting distributions from real estate investment trusts, which are taxable in the hands of the investor, thus generating future tax liabilities and possibly a higher marginal tax rate than 20%.
The Satrix Divi Plus ETF pays out on a quarterly basis, which is probably not ideal given that most retirees have spent the past 40 years working off a monthly budget and income. Consequently, getting income on a quarterly basis injects an unfamiliar budgeting time frame and additional spending discipline. While not insurmountable, it does detract somewhat from the offering when considering it against RSA Retail Savings Bonds, which can pay out interest monthly, or an annuity, which will also pay out monthly.
One of the peculiar points of the Satrix Divi Plus, according to the Satrix website, is that “the index consists of 30 companies that are expected to pay the best normal dividends over the forthcoming year. The selection of the 30 shares is therefore not based on the market capitalisation of the shares, but rather the ability of the company to pay superior dividends.”
Most high-yield or dividend ETFs and unit trusts tend to construct portfolios based on stocks with a long track record of paying dividends, the so-called “dividend aristocrats”, which tend to remain in the portfolio for extended periods.
The Satrix Divi Plus employs a different strategy, aiming to select the top-yielding stocks over the next 12 months. This approach incorporates active management, portfolio turnover and market timing, all of which have their own advantages and disadvantages and impacts on overall performance.
Everyone knows that investing is about total return, not just dividends. The latest fact sheet for the Satrix Divi Plus reflects a five-year annualised return of 13.04%. In comparison, the Satrix Top 40 ETF has returned 15.94% over the same period, but yields only 2.83%. Therefore, you are giving up nearly 3% annualised return to get a higher ongoing dividend yield from the Satrix Divi Plus.
This does not make much sense. Looking at one- and three-year time frames, the annualised return differential between the two ETFs is even more pronounced, with the Satrix Divi Plus significantly underperforming the Satrix Top 40.
All of that might change in the future. But investors can only peruse the current fact sheets for investment decisions being made today — bearing in mind the old mantra that past performance is not a guide to future performance.
The total expense ratio for the Satrix Top 40, at 0.10%, is also noticeably lower than the Satrix Divi Plus’s, at 0.41%. That difference over a 25-year retirement adds up to a decent chunk of fees and potential performance drag.
The Satrix Divi Plus ETF is a realistic option for investors wanting yield from their investments, but it’s also worth considering other options and strategies.
YIELD FOR EVERY MONTH
Looking past the default option of the Satrix Divi Plus ETF, it could be a useful exercise to try to assemble a monthly income portfolio with a mix of assets. While the goal of the theoretical portfolio is to generate income for investors, there should be some acceptable capital growth from the equities, giving a fair total return over time.
Unlike the Satrix Divi Plus, which pays quarterly distributions, this theoretical portfolio has money coming in monthly. Current yields are as at the time of writing.
January
A favourite US dividend stock is Realty Income, which pays out every month. The real estate investment trust (Reit) owns properties across the US and UK as well as in seven European countries. It has paid dividends for 662 consecutive months and increased its dividend every year for 30 years. As it pays out in dollars, it provides a rand hedge element, though investors would have to accept some currency translation risk if the rand really strengthened. Current yield: 5.4%
February
Another international dividend cornerstone would be the world’s largest alternative asset manager, Blackstone, which at last count had a not insubstantial $1-trillion under management across private equity, real estate, credit, infrastructure and hedge funds. This stock will provide valuable exposure to assets that are not readily available to retail investors, offering a potential negative or low correlation to global equity market fluctuations and some more rand hedge income. Current yield: 2.6%
March and September
This is cheating somewhat, as this option pays out in two separate months. RSA Retail Savings Bonds are too good to look past in the current environment, with real yields around 6% based on the current five-year fixed bond at 9.25% and inflation of 3.5%. Even if inflation rates rose from here, it’s hard to see a situation where investors are not earning a real yield over the term. RSA Retail Savings Bonds also come with zero fees. For those in early retirement or just about to retire, there’s a potential rollover risk to consider down the line, but this is balanced by mitigating a significant drawdown and sequence of returns risk in the early years. Investors should also consider maximising their interest exemption from the South African Revenue Service every year to lower their effective tax rate.
April
JSE Ltd, Africa’s largest stock exchange operator, is the yield stock pick for April. The JSE has a cash-generative business model, and it ticks a lot of boxes on the income yield checklist. While it faces some structural issues, it has diversified its business model over the past few years and is now a more diversified financial services business. It also boasts an increasing dividend over time, with a few special dividends thrown in along the way. A debt-free balance sheet provides comfort when thinking about future dividends. Current yield: 6.33%
May
Moving abroad, investors should take a closer look at one of the stalwarts of the investment trust sector in the UK, the City of London Investment Trust, which sits in the UK equity income sector. It has increased its dividend annually for 58 years, payable every quarter, and payments are generally evenly spread across the four quarters, with the annual increases typically coming in May. With a high-quality portfolio of FTSE-listed shares such as Shell, Tesco and NatWest, as well as a long-term investment manager, it warrants an inclusion. Some more rand hedge income, but this time via a different currency. Current yield: 4.2%
June
Next up is JSE small-cap counter Araxi Ltd (formerly known as Capital Appreciation), another business that has delivered consistent and growing dividends since its IPO. It has a rock-solid balance sheet, with about R400m cash in the bank. It pays an interim and final dividend. Like many other companies, the final dividend tends to be higher, and the cash typically hits investors’ brokerage accounts in June. Current yield: 6.6%
July
No self-respecting yield fund would be without a few real estate counters. The pick from this sector is Stor-Age, a decision based largely on the company’s vastly diversified customer base. This specialist Reit includes a good mix of South African and UK assets, along with some high-margin ancillary revenue and decent-looking growth prospects. The recent reduction of the payout ratio to 90%-95% actually enhances the sustainability of the distribution over time. Current yield: 6.66%
August
Hudaco Industries, which distributes automotive, industrial and electronic consumable products across South Africa and Southern Africa, is another JSE stock that quietly ticks over in the background and manages to deliver for shareholders even in times of poor economic growth. Despite the challenging operating conditions in South Africa, the company has achieved success thanks to solid operational management and a history of savvy bolt-on acquisitions. It has a long track record of returning cash to shareholders and a stated policy of maintaining dividends as part of its overall capital allocation policy. Investors should be confident about future payouts here, despite some debt on the balance sheet compared with the more cash-flush names in this theoretical portfolio. Current yield: 5.65%
October
JSE banking and financial services heavyweight FirstRand. As one of the largest banking groups in South Africa and with an excellent track record of paying dividends, it is a staple in a high and sustainable yield portfolio. While Capitec is the growth star of the banking sector, FirstRand still boasts a return on equity of 20%, a reasonable valuation and a decent yield for income investors. The pending final dividend payment is slightly higher than the interim dividend paid earlier in the year. Current yield: 5.65%
November
The next stock is likely to be unfamiliar to many local investors, but Washington H Soul Pattinson & Co (Soul Patts) is a diversified investment company listed on the Australian Securities Exchange. It is a high-quality business with a long dividend history, having grown dividends at a rate of 9.8% annualised since 2000. It is in the throes of a merger with one of its largest subsidiaries, which will introduce a huge industrial property portfolio, along with Australia’s largest brick manufacturer, while remaining controlled by the founding Milner family. It pays an interim and a final dividend, but the final dividend tends to be higher. The initial yield is a little low, but remember the history of dividend growth. It also provides another rand hedge with a different currency exposure. Current yield: 3.75%
December
Finishing the 12-month yield cycle is local asset manager Sygnia, which generally drops a dividend like Father Christmas dropping off gifts under the tree in December. While it also pays an interim dividend, it usually pays a larger final dividend. Sygnia has grown steadily over time, and with a debt-free balance sheet, it’s another one that looks attractive for income investors. Current yield: 7.56% — Mark Tobin.
The FM’s more adventurous yield portfolio
Dividend seekers on the JSE will obviously cluster around the redoubtable larger-cap shares such as British American Tobacco (even if its yield has diminished after a near 40% share price gain over a year), banking groups such as FirstRand, Absa and Nedbank (yielding more than 10%) and large and flush mining groups such as Exxaro.
For those prepared to chance their arms on smaller-cap stocks, there are some enticing options in which the opportunities and risks are finely balanced.
Here are the FM’s five picks for the more adventurous dividend seekers:
SUN INTERNATIONAL: Punters who fancy longer odds might prefer to back Tsogo Sun, which is certainly rated far more modestly after falling behind in the online gaming chase. However, Sun International looks better positioned to keep up with the early leaders in the lucrative online gaming segment — having already shown that it can grow this new segment at an impressive pace.
While further thrusts in online gaming and online casinos could require extensive capital expenditure (for marketing alone), there could be a reassuring bolstering of the balance sheet if the group’s smaller casino precincts can be bundled together and sold off.
What could stanch dividend flows? If Sun decided to buy up market share in the burgeoning online gaming space in a big way — perhaps revisit the acquisition of rival casino group Peermont (which looks unlikely).
AFRICAN MEDIA ENTERTAINMENT: Perhaps eMedia, the owner of e.tv, eNCA and OpenView, would be the share to tune into for dividends — and the 12% yield does look attractive. African Media Entertainment, which earns most of its keep in the radio space, offers a simpler cash flow-generative business model that has defendable regional niches. Nicely priced on an earnings multiple of five and a 10% yield.
FRONTIER TRANSPORT: Driven mainly by Golden Arrow Bus Services, this perennially profitable passenger transport enterprise looks a giveaway on a trailing earnings multiple of 5.4 and a yield of more than 9%.
It is tasked with transporting a huge segment of Cape Town’s workers from home to work and back again, and its lucrative government subsidies add extra lubrication to a well-maintained operating engine.
Innovations such as electric buses and smart ticketing systems should ensure that margins remain firm. Intensified competition from the local taxi industry and a cut in government subsidies are persistent risks.
CAXTON & CTP: This publishing, printing and packaging conglomerate is hardly eye-catching in the yield rankings, sitting at a decent enough 5%. Caxton, though, is priced for disaster — when the core business actually generates heaps of cash and, in the case of packaging, ekes out some growth.
Presuming the group cannot press for a full takeover of rival packaging group Mpact, the balance sheet arguably holds much more cash than Caxton would ever need to maintain, upgrade and even expand existing operations. Dividends are covered about 2½ times by earnings, but could conceivably go lower with so much cash sloshing around the balance sheet.
ZEDA: Car rentals and fleet maintenance are not businesses that get investor pulses racing. But Zeda, which owns the Avis and Budget brands, has been a steady performer since being unbundled from industrial giant Barloworld. Certainly, an earnings multiple of less than four and a yield of more than 8% suggest a business badly stalled — which, in these times of ride hailing, is quite understandable.
Zeda, however, commands a lucrative slab of the rental and leasing market, and should churn consistent profits. With acquisitions unlikely (at this point) and debt levels driven down, there is scope for sustained dividends of decent denomination. — Marc Hasenfuss
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