The case for high dividend stocks
One of the reasons why I am bullish on the Philippine stock market is the abundance of high dividend yield stocks.
In my opinion, stocks with high dividend yields are a very attractive alternative to bonds for long-term investors, especially with interest rates expected to go down and the country’s economic growth outlook improving.
Note that the Philippine 10-year bond rate is currently 6.1 percent. However, since interest income on bonds is taxed at 20 percent while cash dividends on stocks are taxed at 10 percent (for individuals), a stock with a dividend yield of 5.4 percent provides investors with a similar level of passive income as the 10-year government bond.
Right now, there are many stocks with dividend yields of at least 5.4 percent.
Aside from utility companies (i.e., power, water, telcos) and REITs, some banks and consumer companies also now provide similar levels of dividend yields.
In addition to providing a competitive level of passive income, high dividend yield stocks have the potential of delivering significant capital appreciation once sentiment for the stock market improves.
Stocks are undoubtedly very cheap right now, with the PSEi index trading at only 9.3X P/E, which is more than two standard deviations below its 10-year historical average multiple of 15.5X.
Earnings growth
If the index’s valuation reverts to the mean, capital appreciation potential is more than 60 percent! Upside could even be higher since the stock market also benefits from faster earnings growth that results from improving economic conditions.
High dividend stocks could also outperform the market in the short term since most companies announce their dividends shortly after disclosing their full year earnings results.
Note that the fourth quarter earnings season already started this February with BPI, UBP, GLO and RRHI kicking off the season.
However, when buying high dividend yield stocks, research is important.
Aside from the dividend yield, it is important to determine the stock’s earnings growth outlook.
Cheap valuations
This is because companies usually have a policy of setting aside a certain percentage of profits as cash dividends.
Consequently, if profits go down, dividend payments also go down. As such, the resulting dividend yield could be lower than expected.
Moreover, focus on high dividend stocks that are trading at cheap valuations.
Aside from having a higher capital appreciation potential, buying cheap stocks reduces the risk of losing money in case the need to sell the stock arises.
Finally, use long term money.
Unlike bonds where coupons are fixed, cash dividends are dependent on the company’s profits and are therefore not guaranteed.
As a result, prices of high dividend stocks can also be volatile and may disappoint investors who are expecting their prices to consistently trend higher.
