I love dividends.
To me, receiving a regular dividend payment concretizes the rewards of stock investing.
I like to think of them as wages. Instead of paying me to drive a truck, man an assembly line, or sit behind a desk, however, the company pays me to provide it with capital.
To be sure, there’s not much labor required to perform this “job.” I simply need to ask my broker to buy some shares.
But just as I have a limited amount of time to offer an employer each week or month, I also have a limited supply of capital.
So, I want to receive the best wage I possibly can in return for investing it.
The Johannesburg Stock Exchange is home to a number of excellent dividend stocks, but before I share some of my favorites, let’s look at some of the elements that separate good dividend payers from dodgy ones.
Stocks That Pay Generously
Investing in a stock without dividends is like taking a job at a small technology start-up. They don’t pay much at first. Instead, they promise rapid growth and big dividends in the future. Investing in them is risky if you’ve got bills to pay and a family to support.
Stocks with high dividend yields are often a more prudent choice. A share’s dividend yield shows us how much of a “wage” it pays in relation to its price. To calculate it, we simply divide the total dividend per share that the company paid over the most recent 12 months by the current share price.
dividend yield = dividend per share / share price
Stocks with dividend yields above 5% are generally considered to be high dividend-payers. So I’ll screen the shares listed on the Johannesburg Stock Exchange for companies that meet this criteria.
There are currently 71 JSE stocks with dividend yields greater than 5%.
Could I “take a job” with any one of them? Yes, but without further research, doing so may lead to anxious, sleepless nights.
Why? Because some companies are more generous with their dividend payments than they can afford to be.
Beware High Debt Loads
I once worked for a company that paid quite well.
Unfortunately, the company also carried a very heavy debt load.
When the economy turned sour, it could no longer afford to service its debt, let alone pay wages to employees like me. So, it soon went bankrupt.
Similarly, companies with high levels of debt may be forced to cut their dividend if market conditions deteriorate. It wouldn’t be wise to depend on them for steady income.
So, let’s look at our list of 71 companies and remove any with debt levels higher than 70% of their book value. We calculate this debt to equity ratio by dividing all of the company’s interest-bearing debt by its total equity.
Companies like PPC, which took a big loan a couple years back, and most real estate companies have debt/equity ratios higher than 0.7 and are removed from further consideration.
That leaves us with a group of companies that have some resilience to weather tough times without immediately cutting dividend payments to shareholders.
We’re making some progress.
Don’t Forget Growth
Now, let’s add a growth component to the selection process.
Just as we’d like to work for a company that regularly raises the wages of its loyal employees, we want to invest in companies that appear capable of growing the amount of cash they pay to shareholders.
To help us make this judgment call, we’ll remove companies with payout ratios greater than 70%.
The payout ratio measures how much of each rand a company earns that it pays in the form of dividends. It’s calculated as follows:
payout ratio = dividends per share / earnings per share
The higher the ratio is, the less cash the company is retaining for the purpose of growth. A company with a 90% payout ratio, probably doesn’t intend to grow very much. A company with a 10% payout ratio, however, most likely intends to grow quite quickly.
Safety in Size
Let’s further winnow the results by removing very small companies, those with a market capitalization less than ZAR750 million (roughly $50 million).
Such companies face the risk of being crowded out of the marketplace by larger competitors. Thus, a steady dividend from them is less than a sure thing.
This removes some interesting micro-caps like Verimark and KayDav Group from the list of contenders.
Consistency is Crucial
Finally, let’s take a look at the dividend payment history of each company that remains on the list.
We want to eliminate companies that slashed their dividend at any time during that time period. Why? Because if they reduced their dividend one time, they may very well decide to do so again.
The Rock Solid Dividend-Payer Screen
To recap, we screened the market for shares that met the following standards:
1. Dividend yield > 5%
2. Interest-bearing Debt to Equity Ratio < 0.7
3. Payout Ratio < 0.7
4. Market cap > ZAR750 million
5. No dividend cuts in past five years
7 Solid South African Dividend Stocks
When the dust settles, we’re left with a group of seven companies from a range of industries – all of them look steady as a paycheck.
(Note the table below was updated on 24 June 2016.)
|Yield||LT Debt/Equity||Payout Ratio||Market Cap|
|Combined Motor Holdings||7.7%||9.3%||45.1%||R1,271m|
|Standard Bank Group
Disclosure: I hold a beneficial interest in shares of Nedbank, Liberty, and Standard Bank.
What Do You Think?
What are the essential ingredients of a good income stock? Do you have a favorite that you’re willing to share? Let’s hear your thoughts in the comments.