Ep 88: 3 Concepts that Will Make You A Better Dividend Investor

If you are entertaining dividend investing as an investment strategy, then generally your goal will be to derive consistent returns. Essentially, consistent income source is what you’re seeking for. It does not need to be 10, 20, 30, 40, 50%, but it needs to be that 4, 5, 6, 7, 8% that you can get annually, biannually or what have you. You want it to be consistent. The core idea is consistency. 

So when you’re trying to build something like that, there are many, many different ways. It’s not just about dividend investing. You can entertain high yield corporate bonds. You can entertain a mix composite strategy, which is why a lot of people out there propagate index investing, you build a composite then you keep drawing down.

All those things are possible, right? You have many ways to go about doing it. So the question today is not about whether dividend investing is superior to that of buying bonds or using long-term index fund strategy and blah, blah, blah… I’m already assuming that you have a general idea of what you’re seeking and you have decided that you want to use dividends as an investment strategy to generate income for you.

If you are still in the midst of understanding all these different investment strategies… hey, just look at the stack that we have. We have already recorded so many content that I reached a point where I don’t even remember what I’ve said already. There are a lot of things that we have recorded prior, you can go and check out all the investment-related episodes to find the thing that fit you.

And if you are entertaining dividend as an investment strategy, the core idea then is about finding good companies that are fundamentally strong, have a very resilient business that can keep paying you the kind of cash that you’re looking for in the form of a dividend. So two main ideas: one is whether the company is fundamentally strong, the other is whether the company is willing to consistently pay you that kind of dividend. 

These two are important, which is why there’s a natural tendency for a lot of dividend investors to go for these seemingly huge companies that don’t really have competition like your big banks, they’re oligopoly here if you have not realized. There are three big banks in Singapore, which shall not be named, but they make up 40% of the Straits Times Index, or FMCG (fast-moving consumer goods) companies are people that sell your drinks, your Nestle, your Thai beverage… these very, very big companies that have a dominant position in their space and in their industry essentially, also like your utilities and your properties. They tend to pay out decent dividend and they are very, very big. That is the underlying assumption. 

While we are not seeking capital gains, that means we don’t need the company to grow, grow, grow, grow, grow and reflect that kind of growth in their stock price, we also don’t want to look for weird companies that end up… can only pay us two quarters and that’s it! End of story! Big companies that are willing to pay out consistent dividend is generally the formula, and I have extensively talked about what to look out for in the fundamentals of a business, from their revenue to their margins, free cash flow, costs of goods, dividend payout, blah, blah, blah… all those things, we’ve talked about it a lot whether is it in the REITS episode or the fundamental analysis. So please go and check them out. They’re all in the podcast stack. 

Later this week, Sudhan from Seedly will be coming on to talk with me about banks, SQ, Singtel… so we’re literally going to the names and we’ll talk about their fundamentals and what is their business situation at this moment in time.

So I will not go into all that, but I would like to share with you three concepts that will make you a better dividend investor after you learn all these fundamentals. Assuming you understand the fundamentals of a company, the very first concept I want to introduce to you is the idea of terminal growth. I get it, we don’t want to go for big capital gains. We don’t need our companies to keep growing and keep growing, 10%, 20%, top line. Those are like growth space, right? We’re okay with our companies just being in the business, being dominant and being strong and just keep paying us dividend. But we cannot have a company that is shrinking because that will directly shrink the dividend, like it or not. 

Terminal growth is a concept where the company continues to grow aligned with inflation. That means about 2-3%, given current standards of inflation. That’s a major assumption. If inflation goes up to 10, 20%, then you expect your company to grow at 10, 20% to at least meet the kind of inflation standards. But assuming 2-3% is the current standards that we have all agreed upon, then the idea is you want terminal growth because if the company continues to grow revenue at 2-3%, it will be able to offset increase in cost, labour cost, product cost, whatever costs, all the other costs aligned to inflation. 

Terminal growth as a central idea is very important. You cannot buy companies that seems like they’re very big, they’re not really growing because if they’re not growing, at least at terminal level, then essentially they are shrinking, they’re getting eaten up by inflation and someday they will just cut back on their dividend and dah, dah, dah… and then tadah, 没有了 (no more already). 

Which is why it irks me quite a bit when I hear people talk about buying big name companies, like OCBC, Singtel, StarHub and whatnot. Okay, I will not continue to name names, but the idea is this is not a recommendation. But I get very irritated at the coffee shop where people talk about this “oh wa buay Singtel (I bought Singtel)”, “oh I bought OCBC because you know, very big mah. Will not… nothing will happen. And then if go up, go up lor. If not, I take dividend lor.” Wah piang (exasperated)! Okay, it sounds like dividend becomes this consultation price: if you fail to meet your objective, then not bad lah, there’s some sort of dividend [laughter] 

Okay, but that is a fundamental error, we will not emulate that. We want you to have a clear goal what we are going for, the strategy that we’re going for and if dividend investing is the thing, look for terminal growth. Looking for terminal growth is one of the core ideas to help you stay aligned with inflation and to make sure your company is at least growing aligned with market. It’s moving along. It is not growing very fast but it’s straddling along. It’s not dead, it will not shrink.

While I say terminal growth (2-3%) is what I’m looking for, I have a caveat for you, and that is I want to make sure that the margins is kept consistent, which means my cost of goods to my revenue, the difference is kept consistent so that it can have consistent free cash flow. Free cash flow is important because free cash flow essentially is the money that the company makes at the end after you minus everything. So top line revenue being in terminal stage (2- 3%) is to ensure that the free cash flow is kept at consistent… free cash flow don’t need to grow, but it at least needs to be consistent. Why? 

Which brings me to point number two, and that is the company’s net dividend payout needs to be smaller than that of free cash flow. We’ll talk about this after a word from our sponsor. 

 I think one of the main concerns people have when it comes to dividend investing is whether the company will keep paying out dividend. So then you got to ask yourself whether the company has the ability to keep paying out dividends. Other than the whole idea of terminal growth, the balance sheet is fundamentally strong, revenue is good, margins are good, cost of goods are kept constant and it has a good history of paying out dividends. At the very core, you need to recognize that the business itself is making more money than it is paying out its dividend. So net dividend payout essentially is all the dividend that’s being received by every one of the shareholder, which means your dividend per share times the total amount of shares. That is the net dividend payout of the company and you want to make sure that the company’s paying out less than its free cash flow. That means it still has money left after deducting all the different, different costs. 

It’s like your household expenses. Say you make $5,000 and then you minus your rental, minus your food, minus everything, everything minus everything… You’re left with $1,000 and this is your free cash flow as an individual. What do you want to do with this? You can decide, you want to save it. You want to invest in something else. You can treat your friend and whatnot. That is up to you.

From a company’s perspective, that is the same idea. After deducting everything, that is the free cash sitting around, free cash flow and what do they do? They tend to give out a dividend so that they can keep you invested and have you stay around and continue to be that shareholder. They want to make you happy also mah, right? You invest in them, I give you some money. Okay mah. There are actually a lot of people that invest for dividend, so you see that sometimes when companies cut back on dividends, their share price will get affected also. So in order to make sure the company does not cut back on their dividend, you want to make sure that for an extended period of time, they are actually paying out less than their free cash flow but they are consistently paying out the same amount, or a little bit more as it goes along. Why not?

There’s also an issue with fraudulent payout. What do I mean? It’s not very common. I’m not saying that every company is out there to fraud you. Relax, relax huh? But if the net dividend payout of the company is bigger than the free cash flow, then you got to ask yourself where’s the money coming from? What happens a lot of times is these companies will end up issuing corporate debt. So they issue the debt then they take the money to pay out the investor, which is not very healthy because then the company’s fundamental financials become wonky.

Imagine it’s like you got credit card bills. You need to pay your credit card bills, but then you go and borrow from another credit card to pay this credit card so that you make this credit card bill owner happy. So that’s the idea, right? Some companies, if they are not doing well fundamentally and they are not willing to cut their dividend, they end up paying out more dividend in their free cash flow. Over time, it is not healthy because although short term they make you happy, oh you still continue to get your 5% dividend payout but a few years later, the amount of corporate debt or the amount of financial engineering that goes within a company, it’s going to make the company fundamentally very wonky.

So to me, as a dividend investor, I want to make sure that net dividend payout is smaller than my free cash flow. And then best ah, if they have a little bit of extra free cash flow, they can invest a little bit back into their business or they can buy some extra equipment. They can upgrade our stuff and continue to stay competitive so that they can achieve at least terminal growth. 

Which brings me to point number three and that is out of the company. It is about the tax situation where you are invested. I’m sure by now you probably have heard that Singapore government does not tax your dividend payout. Every single dollar that comes out of the company as a form of dividend, you are not taxed. So if the company gives you 50 cents, you take the 50 cents. The company gives you $2, you take the $2 and go and do whatever you want. You can reinvest, you can go and buy something else. You can treat yourself, what have you. You can do your beautiful thing that you seek too. 

But if you’re investing abroad… I think a lot of people are investing in the US so you probably have a general idea that if you are invested in the US, every single dollar that comes out of the US company as dividend, you are taxed 30% as a foreigner withholding tax. So it means every dollar that comes out, you only get 70 cents. The US government takes 30 cents. There are other jurisdiction. In China, it’s 10% on dividend. Hong Kong is tax-free. Malaysia also does not charge you on dividend tax. 

So if you want a clearer summary of how much… which country is taxing their dividend, then you can head over to taxsummaries.pwc.com. Hashtag #notsponsored, but I think they have some of the clearest tax sheet. taxsummaries, S-U-M-M-A-R-I-E-S dot pwc dot com. When I was searching for information, they gave me the simplest, cleanest way to look at it. Of course there are other index funds or dividend funds that pride themselves for being tax efficient, that means they have a domicile somewhere, blah, blah, blah. It’s a little bit more complicated. We’re not talking about it today, but those are what they call tax-optimized portfolios. That is also one way to go about reducing tax. 

But the main idea is if you are investing for dividend, you have to be cognizant of the tax situation where you’re involved in. Don’t just invest thinking “wah, I’m going to make more dividend because I invest here”, but you don’t actually know how much it’s going to be taxed. Which is why every time we invest abroad, we gotta be consistent and cognizant about tax structures, forex rates, all those kind of stuff. But specifically for dividend investor, I believe you have to be cognizant of your tax situation to make sure that it achieves the goal that you set out for.

So, simple concepts that I think is under appreciated, not really discussed. I’m going to end off today with this three concepts as a summary. Number one is the idea of terminal growth. If you want to be a better dividend investor, the central idea is to find good, fundamentally strong companies that pay out consistent dividend. Which means in order to keep up with the times, you want to make sure that your company is still growing. It does not need to grow a lot, but at least 2-3% to beat inflation, which is the idea of terminal growth. 

Point number two is net dividend payout needs to be smaller than free cash flow, because you want to make sure that every time the company is paying you, they’re not doing all sorts of weird things to pay you. They actually can afford to pay you. Of course you want it to be consistent and all that. But if let’s say the company is really not doing so well and they decide to cut back on dividend, then you can re-decide on whether you want to stay with them, or you can sell the company. But at the core, you must make sure that net dividend payout is smaller than free cash flow. 

And number three, the last point is you have to be cognizant of the tax situation. Sometimes we are excited, we want to get our yields elsewhere because there’s more yield and more dividend payout in other countries, blah, blah, blah. But if you’re not cognizant of the tax situations, you cannot factor that into your investment strategy. So I hope this three concepts will help make you a better dividend investor and I hope you learnt something useful today. See ya!.

Hey, I hope you learnt something today and truly appreciate that you took time off to better your life with The Financial Coconut. Knowledge, it’s that much more powerful and interesting when shared, debated, and discussed. Join our community Telegram group, follow us on our socials, sign up for our weekly newsletter. Everything is in the description below. And if you love us, want to help us grow, definitely share the podcast with your friends and your socials. Also, if you have some interesting thoughts to share or know someone that you want to hear more from, reach out to us through hello@thefinancialcoconut.com. With that, have a great day ahead. Stay tuned next week and always remember: personal finance can be chill, clear and sustainable for all.

Woo! Yay, so happy to be talking about investing again. I know a lot of you like to hear investment-related topics. We’re also building a backend with all these investment-centric content where we review certain companies, we talk about their fundamentals, we help you along in this process of learning what to look out for in different sectors and different things that are unique to certain companies. All of that will be coming up very soon. 

For this month, it’s a little bit of a campur (mix). There’s a little bit of investing and we’re also working with Providend. Providend will be coming on to do a series with us, talking about financial planning at different stages of your life, mini retirement, estate planning, young family and of course they are famous for the whole term versus life kind of thing. So we did a series with them. It’s going to come out mid of this month. 

For later this week, Sudhan will be coming on. I had a very good chat with Sudhan to talk about the different big names in Singapore in terms of the Singapore stock market. While I’m not a big fan of the Singapore stock market, I do own a REIT portfolio, which most of you probably know.  But he started off investing in Singapore, so I think he has a lot of good insights to share about that. So I’ll leave that to him. I had a great time with him. He’s a great guy in terms of his understanding of knowledge, his rigour. So yeah, good time. I’m sure you’ll learn some good stuff. 

Next week, we’ll talk a little bit about some of the global shifts that are happening, or at least the stuff that I’m observing that will affect the way you plan your personal finance. I have some pretty good thoughts to share after interviewing so many people and doing some research, so that’s good stuff. 

Keep helping us grow. Finally, we’re talking about investing again and I know you like it. So yeah. [laughter] Take care, but life is not always just about investing. Go and find some hobby and go and live your life, okay? I’m going to live my life now. Take care guys. Bye.