One of the basic assumptions in economics is that the average investor is a rational person and therefore hates risk. This is also the reason why many investors generally prefer more conservative investments with a low risk at the price of a low return, especially when the markets are turbulent. Despite this, equities, considered a more risky investment instrument, can also turn out to be a good choice for conservative investors, if they focus on dividend stocks.
By dividend stocks is meant companies that usually share their profits with investors and give them a certain percentage of the profit regularly. It is a way of rewarding investors for the company's results during the period just ended (usually the year or quarter). Some companies vary the distribution dates and amounts distributed as dividends depending on their results, while others have a clearly stated dividend distribution policy, which they adhere to consistently. Either way, dividends are distributed between shareholders equally, according to the size of their holding in the company.
The benefits from making a wise choice of dividend stock are twofold: the return it yields as a profitable company that is a success in business terms, and the dividend it distributes to shareholders - again thanks to it being profitable. So the million dollar question is, who has handed out the biggest dividends - in financial terms - in the past five years, and given investors some earnings on their holdings?
We put that question to the research department at Psagot Ofek Investment House Ltd., which took up the challenge. Psagot analyst Yaniv Kunis reiterated the advantages of investing in dividend stocks. First and foremost, it is an investment that enables investors to reduce part of the risk in the stock, since they periodically receive a payout in cash, in addition to the potential capital gain from exposure to the stock. Potential because the profit becomes an established fact only on the day the investment is realized, and anyone who has ever invested in the capital market knows that you can miss the ideal date on which to realize your investment.
Another reason is that dividend stocks tend to suffer less during periods when markets are falling, compared with those that don't distribute dividends. The latter are exposed to sell-offs that are heavier during periods when markets are falling sharply. Kunis adds that dividend stocks usually belong to the value stock group, since in contrast to growth stocks they represent a proven business model, and are not "dream" stocks.
It should be remembered that a company may distribute a dividend solely from the profit it has recorded. A company that wishes to distribute a dividend but does not meet the profitability criteria, will have to obtain special approval from the courts to do so. This situation offers further advantages - companies that usually distribute dividends regularly are characterized by a positive cash flow that reflects their financial stability and allows them to reinvest in their business during periods of growth. Conversely, they manage to remain stable during times of global slowdown or financial crises.
Dividend yield in Tel Aviv - one of the highest worldwide
One of the most important factors that should be considered when on the hunt for dividend stocks worth investing in is the dividend yield. The dividend yield is calculated using one of two formulas - the dividend divided by the company's market cap, or the dividend per share divided by the share price. One has to take into account that the dividend yield produced by these formulas is gross, and by law, shareholders pay a 20% tax on their dividends.
What does the dividend yield show? How much an investor receives on every shekel he or she invested in the stock. The investor's goal is to select the stocks with the highest dividend yield, which shows that the amount of cash they distribute is fairly high. However, it isn't all that simple. Although calculating a dividend yield appears fairly easy, Kunis points out that significance of the result is not clear cut, since the figures obtained show how much the yield was in the past. How much will the company pay in future? That remains unknown. Kunis suggest two methods that can give an idea. One is to calculate the dividend yield on the basis of the latest annual dividend data. The result does not represent the dividend yield for the coming year, but it does provide a fairly good estimate.
The second way is to calculate the forecast dividend, as derived from the consensus among the analysts covering the company, or its stated dividend policy. This is the more commonly used method on the capital market, since it takes into account the company's activity at the present time, and the forecast for the profit from which dividends will be distributed.
This technique is easier to apply in the US capital market, where companies usually announce their dividend policy in advance, including the proportion of profit they intend to distribute, and how often they intend distribute it. In Israel, however, calculating the expected dividend would be difficult if not impossible, since few companies have adopted a stated dividend policy, as the banks have - even if there has been an increase in the number that do in recent years.
Last year saw a further steep increase in the amounts distributed as dividends by Tel Aviv Stock Exchange (TASE)-listed companies. According to TASE figures, a total of NIS 25.6 billion was distributed in dividends in 2007, 30% more than in 2006, and 75% more than in 2005. The average dividend yield on companies in Israel climbed to 3.8% in 2007 and is now one of the highest worldwide. For the sake of comparison, the average dividend yield in London is 3.1% and in Tokyo it is 1.4%. On the other hand, the average dividend yield in Taiwan is 4.2%. According to the figures, the companies listed on the Tel Aviv 100 Index as at the end of 2007 accounted for 90% of the dividends distributed last year.
The top dividend distributors - banks and holding companies
At our request, Pasgot's research department found out which companies have been distributing the biggest dividends on the TASE in the last five years, not in terms of dividend yield, but real figures. In other words the companies that have handed out the biggest sums of money as dividends.
At the top of the list is Bank Hapoalim (LSE: 80OA; TASE: POLI), which has handed out NIS 6.75 billion since 2003. In second place is Bank Leumi (TASE: LUMI), which distributed NIS 6.69 billion. Worthy of note are the sectors the top distributors belong to. In third place after the two banks is Bezeq (TASE: BZEQ), which handed out NIS 5.32 billion. It is followed by Israel's biggest companies, most of them global industrial corporations, or holding companies. Three of them belong to the IDB Group controlled by Nochi Dankner. IDB Development Corp. (TASE: IDBD) was in fourth place with NIS 4.8 billion in dividends; Discount Investment Corporation (TASE: DISI) came sixth with NIS 4.49 billion distributed as dividends, followed in seventh place by IDB Holding Corp. Ltd. (TASE:IDBH) itself with a total of NIS 3.33 billion distributed as dividends.
Teva Pharmaceutical Industries Ltd. (Nasdaq: TEVA; TASE: TEVA), the people's share, was ranked fourth, after distributing more than NIS 5 billion in dividends in the past five years. Israel Chemicals Ltd. (TASE: ICL), controlled by Israel Corp. (TASE: ILCO) came next with a total of NIS 4.69 billion in dividends distributed. Delek Group Ltd. (TASE: DLEKG), controlled by Yitzhak Tshuva came ninth with NIS 1.8 billion in dividends distributed, followed in tenth place by Africa-Israel Investments Ltd. (TASE:AFIL; Pink Sheets:AFIVY.PK) with a total of NIS 1.48 billion.
There is no definite link between company value and the amount distributed in dividends over the past five years. Teva, for instance, actually posted the lowest dividend yield out of the top 10, despite having the highest market cap and coming fourth in terms of the amount it distributed.
Dogs of the Dow like dividends too
Dividend-based investment portfolios are nothing new on financial markets. According to a study conducted by Dow Jones in 1992-2001, the yield on an investment in companies that distribute dividends was 17.1% higher than the average yield on the stock market. The logic underpinning these statistics is that when prices are falling, investors prefer to limit their risks and value cash in the hand, such as dividends, more than theoretical capital gains on paper.
These are the principles on which the Dogs of the Dow strategy, first developed by Michael O'Higgins in 1991, is based. The strategy argues that if, instead of investing in all the Dow Jones-listed companies, investors focus on just 10 stocks with highest dividend yield on the index, they will beat it. The method proved effective in the past, although it has been less of a success over the last decade. The Dogs of the Dow list, meaning the list of stocks with the highest dividend is updated once a year and can be found at Dogs of the Dow - Chart of the Day.
Kunis advises those people who wish to build a dividend stock portfolio themselves to analyze the dividend yield and also to focus on three things. The first is to check the company's cash flow and whether it is growing year-on-year. The second is to make use of the analysts' forecasts for the projected dividends. And, of course, one should find out what the company's stated dividend policy is.
Those investors who are unwilling or unable to find the time to carry out checks like these, can invest in mutual funds that choose dividend stocks or exchange traded funds (ETFs) that track dividend indices such as the local Tel-Div 20 Index. Funds and ETFs like these can be found on most of the sophisticated markets worldwide.
Published by Globes [online], Israel business news - www.globes-online.com - on August 28, 2008
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