“People talk about this being an uncertain time,” Warren Buffett, the master punter of value stocks once said. But, he added “you know, all time is uncertain”.
Still, rising inflation, rampant oil prices and Russia’s belligerence don’t make for much certainty — raising a legitimate concern for many dividend-dependent investors and pensioners: where to invest now. Inflation, or the expectation thereof, plays a disproportionate role in valuing stocks and other assets (such as property).
So valuing a business entails discounting future cash flows to calculate its current valuation. This way of calculating the value of a stock isn’t benevolent to growth assets, such as hi-tech businesses. However, value stocks may benefit from a rising inflationary environment. These are usually strong dividend payers.
“It is important to first recognise that any dividend investment strategy using dividend yield as the key construction measure is effectively a value strategy,” says Nico Katzke, head of portfolio solutions at Satrix.
But Kaitlin Byrne, portfolio manager at M&G Investments, says the investable universe for dividend-focused stocks isn’t limited to value stocks.
And, she says, “a company that is able to return part of its earnings to shareholders in the form of a dividend [and] grow those dividends over time at a decent rate may have a lower dividend yield”.
To track the performance of “dividend stocks”, the FTSE/JSE dividend plus index acts as a local gauge. The index tracks the top 30 stocks according to their forecast one-year dividend yield and draws its constituents from among the JSE’s top 40 and mid-cap indices — in essence the top 100 listed companies in SA.
It’s a strategy that has, in the recent past, worked well.
Covid really threw a bag of snakes at dividend payers
— Ray Shapiro
For the five years to end-February, this index produced a total return (including dividend payouts) of 120%, compared with the top 40’s 86.1% and the all share index’s 76.1%, according to FTSE Russell.
On an annualised basis, the dividend index returned 17.1% over five years and 19.4% over three years — beating both the top 40 and all share indices. On a 12-month basis, the dividend index returned 46.8% compared with the top 40’s 20.1% and the all share’s 20.5%. Not a shabby performance for the JSE's dividend clique.
It wasn’t all smooth sailing for dividend investors during the Covid pandemic, however.
“Covid really threw a bag of snakes at dividend payers,” says Ray Shapiro, portfolio manager at Counterpoint Asset Management. It was a tough two years, during which consistent payers withheld dividends to shore up their balance sheets and navigate through the uncertainties of the pandemic. But, Shapiro says, “they’re going to make a comeback”.
Dividend stocks’ comeback was strong, as seen in the dividend index’s one-year performance. But Shapiro has a word of caution about blindly following dividend indices.
“A strategy that is really perilous is chasing yield — [that is] chasing the highest dividend-yielding stocks in the market,” he says. “It’s extremely risky. It tends to underperform over the long term.” In terms of the dividend index, Shapiro says that chasing a one-year forward yield “sends you into riskier situations”. That’s because the price of specific stocks may be valued lower due to money managers’ view that these stocks are riskier by nature.
Byrne is also cautious about taking only a company’s dividend yield as a measure for building a portfolio of high-yielding stocks. “We try to select only those businesses that have strong balance sheets and can pay sustainable and growing dividends to shareholders through the peaks and troughs of the business cycle,” she says. “We look as far back as possible in the company’s history to ascertain its ability to generate a sustainable return on capital invested by the shareholders and the company’s liability to convert these returns into cash and ultimately into dividends paid back to shareholders.”
At the moment the dividend index’s top five stocks, with a combined weighting of 39.7%, include Royal Bafokeng Platinum, Impala Platinum, Northam Platinum, Exxaro and Anglo American — all (highly cyclical) resources stocks.
“If you look at consensus earnings forecasts by the sellside ... a lot of earnings are forecast to be negative because people believe that [many] commodity prices are at elevated levels,” Shapiro says.
Fortunately, there are nonresource stocks that have been consistent dividend payers over a long time, bar maybe during the pandemic. Even those that withheld payouts may now emerge as stronger dividend payers.
Byrne says Covid “forced a lot of companies to cut wasteful expenditure, think twice about plans for large capital expenditure that may not produce good returns, and focus on paying down their debt to de-risk their balance sheets”.
Byrne views Famous Brands as a potential up and coming dividend payer. “Famous Brands is an example of a company that had high debt as a result of the acquisition of Gourmet Burger Kitchen but during Covid was forced to make the tough decision of divesting from that business,” she says. “Its balance sheet is now clean, and the excellent cash flows from its core business are no longer being deployed to a loss-making entity, so can rather be used for dividends.”
Shapiro says some traditional names among the dividend payers include British American Tobacco — which has been a “reliable payer” over time though its share price has showed some volatility — the JSE, grocery retailers, Bidvest, Hudaco, Santam, and the banks.
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