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Wisdom (12th March 2012)

Show me the money; Dividend investing to generate income

10th March 2012 The Business Times By Teh Hooi Ling 2012 Singapore Press Holdings Limited At current price levels, high dividend yielders on Singapore Exchange remain decent investment options. THE Straits Times Index (STI) component stocks have done well in generating profits and sharing those profits with their shareholders over the past nine years. Of the 24 STI component stocks which have listing records going back to 2002, their combined dividends paid out grew from just over $4 billion in 2002 to in excess of $16 billion. That's an annual compounded growth of 16.5 per cent. During that same period, net earnings grew by 15 per cent and free cash flow - cash generated by the business after accounting for capital expenditure - by 13 per cent. In the very volatile investment environment that we now live in, investors have come to appreciate relatively safe income yielding instruments. That's why fixed income instruments such as bonds - be they corporate or government bonds - have done exceptionally well. Adding to the attractiveness of these instruments is the fact that savers are getting next to zero from the places where they traditionally keep their money. Indeed, according to BlackRock, the world's largest asset management firm, within its iShares or exchange-traded fund business, dividend fund inflows represented 26 per cent of the global equity total in fourth quarter 2011, up from 6 per cent a year earlier. 'This is often used as a contrarian indicator: If investors are buying, is it time to sell? Is this trade too crowded? The answer is: probably not - yet,' wrote the firm in a recent report titled Means, Ends and Dividends: Dividend Investing in a New World of Lower Yields and Longer Lives. By 2050, the number of people in the world over 65 will triple to a global total of two billion. People are also living much longer. When it comes to investing, these people will look for income. 'Having a predictable and lasting income stream is crucial for paying bills and peace of mind,' it noted. Against this backdrop, BlackRock believes that dividend investing to generate income - and income growth - is worth a good look. Surveying the current landscape for dividend

Sharing Wisdom (12th March 2012) investing, BlackRock concludes the following: * High-dividend stocks tend to outperform most other assets in periods of low or no economic growth - exactly where we are now. * Dividend growth historically has kept up with all but the most extreme inflation environments. * There is potential for dividend growth: US and European payout ratios are at lows while companies are accumulating record cash piles. Even for investors not focused on income, dividend stocks offer advantages for long- term capital growth. * Dividend growth has been a key driver of total return in the long run. * Reinvesting dividends has made all the difference in boosting long-term equity returns. * High-dividend stocks have tended to do better than other shares in both bull and bear markets. But to be sure, dividend investing is no cure-all for fulfilling all retirement needs, noted BlackRock. It is a bit more complicated than buying a basket of high-yielding stocks, noted BlackRock. Consider: * Other asset classes, including investment-grade and high-yield bonds, have tended to outperform dividend stocks during economic downturns. * Dividend yields and growth do not impact short-term results: Capital moves will swamp dividend contributions in most 12-month periods. * High-yielding stocks with no dividend growth tend to underperform those companies that increase dividends over time. Too much momentum? On the one hand, it is clear investors are starting to catch on to the idea of generating equity income in a world starved for yield. On the other hand, it appears there is room for a lot more, said BlackRock. For example, flows into actively managed US equity income funds still pale in comparison to overall flows into US taxable fixed income funds. Investors put US$20 billion of new money into the first group in the first 11 months of 2011, compared with US$120 billion into the latter group, according to Strategic Insight. Do dividend stocks still offer good value? Traditionally in the United Stocks, high yielders have traded at a discount to the overall market and to growth stocks in particular. One reason is that many high-dividend payers are slow growing, reducing

Sharing Wisdom (12th March 2012) the odds for a jump in their stock prices. However, the dividend discount has been narrowing in the recent 'lost decade' for stocks as equity investors started to look for both income and stability. The differential between dividend and growth stocks is now at record lows for US stocks, making high- dividend stocks relatively expensive by historical standards. The flipside of this argument is that US investors, fed up with the stock market's poor capital appreciation in the past decade, have reassessed the value of dividend stocks. However, the trend towards a new appreciation for dividend stocks is not as pronounced in other regions. Top non-US dividend stocks are reasonably priced at less than 10 times forward earnings, according to Empirical Research Partners. This is the only time that has happened since the early 1990s with the exception of the 2008-2009 financial crisis. In addition, the top quintile of dividend payers is still valued at a discount to the second quintile in non-US developed markets, Empirical Research shows. Even the top dividend payers among US large-capitalisation stocks remain good value by absolute standards, trading at less than 12 times forward earnings, according to Empirical. This is the cheapest they have been in the last decade, with the exception of the period during the recent financial crisis. Payouts: room to grow Stocks with a high dividend yield but low dividend growth tend to underperform the broader market. Which is why it is important to review payout ratios - what percentage of earnings companies pay out in dividends. Dividend payout is a function of many factors. Earnings growth is one of them, while strength of balance sheet and current payout levels are others. While earnings growth is currently moderating, company balance sheets have more cash and are stronger than ever. Payout ratios are modest around the world, and at record lows in the US. The 27 per cent payout ratio of US companies is about half the market's historical average. We would expect to see a return to 'normal' payout ratios and an opportunity for investors to collect even higher levels of income. The case for Europe is weaker with payout ratios averaging more than 40 per cent - low but not unusually low. Dividend payments have indeed been on the rise in the US market. After sliding in 2009, more companies are increasing dividends and fewer are cutting. Therefore, argued BlackRock, it is worth focusing on companies with strong free cash flows. Overall, these companies offer good value - the best in a decade in the US market with the exception of the financial crisis of 2008-2009.

Sharing Wisdom (12th March 2012) Of the companies with strong cash flows, the ones that pay no or few dividends now trade at a discount to the high yielders. This is unusual - at least in recent history - and suggests US companies with strong cash flows and low dividends currently offer compelling value. Where do Singapore companies stand? From the chart, you can see that net profit, free cash flow and dividend payouts of the STI component stocks have been on the rise. However, in the last three years especially, companies have been paying out a huge chunk of the cash their business generated every year. The payout ratio for last year was 95 per cent of the free cash flow and 67 per cent of the net profit. Compared to the average in the past nine years, last year's payout ratio relative to net profit is on the high side. The average for the past nine years is 47 per cent. Even then, the cash and cash equivalents of these companies continue to pile up (see chart 2). But not all this cash is available for distribution. Some have to meet short-term obligations of the companies, and some are funded by short-term debts. So it would appear, at least for Singapore companies, any increase in dividends will have to come from improved business conditions. Still, at current price levels, high dividend yielders on the Singapore Exchange remain decent investment options. Connect with Wisdom Capital: Like our Facebook Page (http://ow.ly/9jhni) Follow us on Twitter (http://ow.ly/9jhr2) Visit our website (http://www.wisdomcapital.com.sg/)