Looking at dividend stocks in a downturn

Smart investors can capitalise on a downturn by buying solid stocks at cheap prices. (Rawpixel pic)

In times of uncertainty, it is best to start by assessing the objectives and game plan for investing in stocks.

Some investors invest primarily for dividend income that grows consistently for the long term.

They accumulate shares of resilient businesses that have management teams with a vision for future growth, especially when their stock prices are undervalued. They hold onto the stocks for as long as they remain solidly profitable.

Good investment criteria would be a solid business model, a track record of consistent growth in profitability, a robust balance sheet, good cash flow management, well-discussed plans to sustain growth and attractive valuation ratios.

The following is the writer’s personal account of what he did for his own portfolio.

What happened to stocks during Covid-19?

By March, the stocks in his portfolio had fallen in price by some 30% to 50%. Capital appreciation turned into capital losses in an instant.

Did he sell? He didn’t. He saw it as an opportunity to shop for high quality dividend stocks because the stocks were on “Christmas sales”, especially right after the Movement Control Order was imposed.

He found himself spoilt for choice of solid stocks that were seriously cheap.

But, with only so much to spend he needed to be cautious. The considerations included whether to buy more shares in companies already in the portfolio or to acquire new stocks in which he had never invested in before. Both were appealing.

A real-life example

Take a look at DBS Group Holdings Ltd. On April 6, after much due diligence, he bought at S$18.31 a share and here’s why:

1. DBS has reported continual growth in shareholders’ earnings for the last 10 years with a compound annual growth rate of 12.1%, up from S$2.04 billion in 2009 to S$6.39 billion last year.

It was attributed to a consistent rise in its net interest income and income from wealth management, cards and transactional services while it maintained a stable cost-to-income ratio during the period.

2. Last year, DBS reported a non-performing loan ratio of 1.5%, cumulative total allowances of 94% (or 191% in collateral), a net stable funding ratio (NSFR) of 110%, liquidity coverage ratio (LCR) of 139%, and total capital ratio (TCR) of 16.7%.

The above ratios measure DBS’ balance sheet strength and NSFR, LCR and TCR were above the minimum regulatory requirements of the Monetary Authority of Singapore.

3. Last year, DBS generated S$1.99 billion, or 26%, profit before tax from its operations in Hong Kong and Mainland China.

This is interesting because the Greater Bay Area, comprising Hong Kong, Macau and Guangzhou Province, is considered an area for growth in the long term.

4. DBS has a culture that embraces digitalisation. This is evident from its launch of Digibank in Indonesia and India and the establishment of 33 platforms under the Platform Operating Strategy, which is aimed at building ecosystem platforms to further improve its operational efficiency and lending models via data analytics.

This is important as banking is shifting to be more online or mobile-based from offline.

5. At S$18.31 a share, DBS was trading at a price-earnings ratio (PER) of 7.44, a price-to-book (P/B) ratio of 0.96, and its dividend yield was 6.71% per annum.

Both the PER and P/B ratio were at their 10-year low while the dividend yield was at its 10-year high.

So, given a chance to buy the shares of a world-class bank — with a credit rating of “Aa1”, a track record of profit growth, a presence in the main growth markets such as China and India and that embraces digitalisation – when it was trading well below its valuation ratio and offering 6+% in dividend yield, the writer jumped at it.

But, what if the stock price drops further?

What about loan deferments, the bankruptcy of Hin Leong, Singapore’s gross domestic product contraction of 2+% in the first quarter of 2020 (1Q2020), the circuit breaker due to the Covid-19 pandemic, the protests in Hong Kong, US-China trade tensions? The list goes on.

There is a concern banks like DBS will be affected in the near future. Won’t their stock prices fall even further?

After buying DBS at S$18.31 a share, the price could go up, down or sideways. Given the pessimistic outlook, it is hoped it will drop further in order to accumulate more and not trade for quick profit.

So, if DBS falls to S$18, S$17 or S$15, it would be good news, and one could buy in anticipation that it will drop further in the future.

Fast forward to June

Here is what happened to the investment in DBS and the writer’s portfolio presently.

1. DBS is trading at S$21.16 a share, up 15.6% from the purchase cost. More importantly, DBS paid a dividend per share of 66 Singapore cents, comprising 33 Singapore cents for 4Q2019 and 33 Singapore cents 1Q2020, in early June.

2. Most stocks in the portfolio saw their prices rebound, proving that it has been resilient as it withstood the tough test of Covid-19, economic uncertainty and the current political instability worldwide.

Investing lessons learnt from Covid-19

  1. Keep cash for a buffer and possibly to use as standby reserve to capitalise on stock investment opportunities arising from increasing uncertainty in the market.

2. Focus on building a resilient and defensive portfolio by investing in stocks that have superior fundamental qualities at the lowest possible prices. Buy the stock as if it is to be kept for eternity.

3. Markets are unpredictable. The writer’s portfolio was down 30% to 50% in a matter of weeks, and it could rise back up within months because the fundamentals of the stocks in the portfolio are superior to what is normally demanded by investors.

It will not work if the shares are in companies that reported a string of losses or profit declines for many years.

4. Emotions like fear and greed drive the stock market. It has caused and will be causing prices of good stocks to either ridiculously appreciate or depreciate in the past, present and future.

Market volatility can serve as a friend as investors could buy at ridiculously low prices and sell if they are superbly overpriced in the future.

5. Have an investment game plan and stick to it. It is a liberating way to invest as one is not constantly reacting to the latest news, rumours, reports, tweets or postings on social media, which may or may not impact stock prices.

It would be great to invest with a mindset that anything can and may happen in the stock market.

It would be a fallacy to expect to buy stocks in anticipation of them only going up without a plan for what to do if they fall.

This article first appeared in kclau.com

Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.