Dividend Yield Stocks, Strong and Weak Ones

The Edge did a good summary of decent dividend yield stocks, usually smallish companies, which include Uchi Tec, Panamy, Wellcall, NCB, PowerRoot, White Horse, NTPM, LTKM, UAC and DXN. These shares tend to be fairly consistent and pays out high dividend, prompting their average dividend yield to be in the vicinity of 5%-9%, a very attractive level considering the deposit rates.

Of course there are those long term dividend yield stocks like Nestle and Guinness. These are pure dividend plays as the controlling shareholder is another much bigger company elsewhere. Research and development reinvestment are done at HQ, so they are another kettle of fish.

Part of the issue I have here with high paying dividend smallish stocks is that they are usually owner operated. Most did well to bring the business up to a certain level, after that they just stick around because they own the company. Entrepreneurs may NOT all be excellent professional managers. Being really smart is to know how to take the company to the next level. The key is to hire people smarter than you. Many are just blinded with the ego part. Mah Sing is a great example of hiring well, so too is CIMB. They have this rubbish connection with wanting control. Why would you want 50% of a stagnating company when you can have 30% of a company that is multiplying in value? Herein lies in many small companies not willing to use debt/new shares issuance / warrant bonds to invest strategically to move to the next level. Organic can only get you so far, and usually ends up in mush and foilage.



I am all for good dividends, provided its sustainable and after sufficient reinvestment. These businesses are usually providing strong positive cash flow. The controlling shareholder does not want to sell down their stakes, so what better way than to pay out good dividends.

However, there are pitfalls and traps with high dividend stocks as well. This is particularly so when we are talking of small or young companies (less than 10 years). Go through each one and you will find that some things may not be as wonderful as they seem:



a) Management's compensation - Owing to good cash flow, steadily growing profits, some management (who are also controlling shareholders) may tend to overpay, at times way over pay themselves for the size of the businesses they are running. There are no hard and fast rules, but a CEO for a company that is between RM100m-300m in market cap and/or generating RM30m-50m in net profits should be paid between RM500,000 to RM1,000,000. Anything more than that is unacceptable. What's worse is when there are two or three EDs on board and each may be on RM800,000 x 3 = RM2.4m. It says a lot about how management view their worth in the company and how they are actually managing it. I am all for setting good growth stretch targets and rewarding accordingly, but not when they get a fat salary package for doing nothing much, especially for businesses that are almost self running.

b) Reinvestment - Some companies make RM40m and declare RM35m as dividends. Are they so confident that their businesses are already so solid that there won't be fresh competition around the corner, or that their products will always be in demand. All products need to improve, efficiencies need to be claimed every year either via cost or technological advancements. Failure to reinvest properly will surely doom the golden goose.

c) Next Level - If management is paying out high dividends, does that mean that they have done all they can. Isn't the business scalable? What about investing downstream or horizontal integration? Its scary when management thinks that this is it, no next level. I don't know about you, but stocks are for growth, capital growth. If I really just want dividend yields, there are plenty of REITs, now thats seriously for dividend yield seekers. I certainly expect more from good stocks, and you all should too.

So, you should really examine their business models and see whether it is naive to payout such high dividends.

Posted in: Hanis Zalikha