Buy and hold? No, it should be sell and buy back later

Historically, the month of February is the when financial results of those companies whose Financial Year (FY) ends in December release their FY results. Then at around the 2nd half of April, it is when companies start holding annual general meetings (AGMs). And by the time when stocks go ex-dividend, it should be around early to mid-May. It is a long wait that takes about 2½ calendar months. This is almost 25% of the whole calendar year. For many people, it may be far too long. If nothing happens in between, well and good. We will get our dividends ultimately. As a whole, Singapore blue-chip companies pay very good dividends of around 3.5 to 5%, perhaps a bit higher than HK companies, and certainly much higher than many Japanese companies. With a relatively high yield, there is incentive to hold stocks for dividend. Certainly, this is one of the key reasons why we hold stocks for a long, long time. It is also coherent with Warren Buffet’s buy-and-hold strategy.

For those who have been dedicated followers of Warren Buffet (WB), the game plan is to buy an undervalue stock, hold the stock long enough in hope that the stock value surpasses its intrinsic value and, in the meantime, continue to wait for dividends year after year. Hopefully there is no need to sell the stock and that was why WB mentioned that one should have the conviction to hold a stock forever. There is nothing magical about this strategy. Especially in the American context, whereby the market capitalization of some companies are so huge that they are higher than the GDP of some small economies. As the world largest economy, it has sufficient power both politically and economically to influence how we do our business. Thus, if we invest correctly, for example to put money in the FAANG stocks, our wealth would have multiplied many times. Just 25 years ago, the Dow Jones was around 4,000. Today, it is 26,000. It has multiplied more than 6 times breaking new highs in countless number of times. So, buy-and-hold strategy should work in such a business environment. But can that be said of Singapore stocks? Twenty-five years ago, in 1994, our STI was at about 2,400. Today, it is at 3,200. It has risen only 30% over 25 years, and this is when many blue-chip companies, in particular the banks, were reporting record earnings. And, yet at this time, we are nowhere within the striking distance from the high of 3,875 in October 2007. Of course, different time frames will yield different comparison results but the stark difference in this comparison is good enough to show that buy-and-hold strategy may not work as well in Singapore as in the US.

For one, we are a driven economy. Stock prices, in particular, of those blue chips are especially sensitive to external news. The on-going trade war between the two world largest economies, the US and China, is a blatant example. In the first quarter of 2019, everything seemed to be moving in the right direction, the STI was floating around the level of 3,200. Then it started to move up as we draw nearer to book closure dates of most companies, peaking around end April 2019. The ascent in stock prices in the month of April is indeed pricing in the dividend distribution. By end April, stock prices have peaked and some have already started to fall. And by the time when the stocks go ex-dividend, the fall just before and just after a stock goes ex-dividend would more or less equal to the dividend distribution.

Now, the question is should one sell a dividend stock before the dividend distribution and buy it back later or should one simply hold it through the dividend distribution. Personally, I think many would go for the latter decision, ie. to take dividends. After all, dividend distribution is a certainty once declared. People like certainties. And that is why people are willing to place their money in fixed deposits (FDs) offering at 1-2% than to put their money in stocks providing them a return of somewhere between -5% and 20%, even though the odds is still higher than the FDs. Furthermore, taking dividend gives them their deserving rights to declare how much they have received in terms of dividends for the financial year.

But this may not necessary be the best way to take advantage of dividend distribution. It is like a game of majong (a chinese table tiles game). There is no one fixed way of winning the game. Just take OCBC as an example. On 1st April, the share price opened at $11.11, and closed on 30th April at $12.10. This price difference of $1 per share would have easily covered the dividend distribution of 23 cents per share and to pay for the brokerage plus all other charges for the sell and buy back executions. Of course, one has to be aware that it may not be worthwhile for a small trade lot of 100 shares due to the imposed minimum brokerage by brokerage houses. But, certainly, a quantity of 1000 shares would be sufficient to tip this balance. All this are within our predictions and that was why I mentioned in the last post on OCBC scrip dividend that the share price is likely to be high at the point of conversion as the date is near to book closure. Given this time when the trade-war, between the two largest economies that started in mid-2018, is beginning to bite into the real economy, shares prices are less likely to maintain its upward march or even remains unchanged after the dividend distribution. Certainly, the announcement of US tariff on the additional $200b worth of China’s goods on 10th May 2019 accelerated all that. And by now, many blue-chip stocks have already sunk to some extent, and probably more going forward, at least in the short term. In fact, the fall in the share price probably could equate to several times of the dividend distribution. By the end of trading day on 17th May 2019, OCBC shares closed at $11.15, even below the price when their financial results were announced on 22 February. Many other blue-chip stocks also exhibited the same price movements in the same period.

For those who had sold their stocks before they go ex-dividend, they are having their last laugh. President Donald Trump had shot down some high-flying ducks for easy picks on the ground. While their compatriots are away as in the saying “Go away in May”, pre-dividend sellers are probably on look-out to buy back the stocks that they had sold. With the remainder, they can buy more stocks than what the dividends can provide to create a quasi-scrip dividend as I had mentioned in my last post on OCBC scrip dividend. And certainly, a sumptuous dinner to go along with it.

Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell out of the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.

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Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.

OCBC Scrip dividend

Along with the other banks, OCBC has recently announced the FY 2018 results. The net profit improved 11% from S$4.05b to $4.49b. Apart from its subsidiary, Great Eastern’s disappointing results, I would say that OCBC did well for FY 2018. Along with the reasonably good results, OCBC is offering a dividend of 23 cents per share for H2 FY2018, representing a dividend payout of about 41% for the whole year. This is, however, lower than its peers like DBS and UOB. The dividend payout for DBS and UOB is 56% and 50% respectively.  (Click here for the performance numbers.)

Over the years, OCBC appeared to have a greater propensity to pay out scrip dividend compare to the other two banks. This is the 12th time that the bank proposed scrip dividend since the global financial crisis in 2009 . To incentivise the acceptance of scrip dividend, OCBC is offering  a 10% discount on the final weighted average price from 3 May to 6 May 2019 (inclusive).

The question to many investors is – what is the purpose of the bank distributing scrip dividend? And is scrip dividend good or bad for shareholders? To me, there is no absolute advantage or disadvantage in having scrip dividends. It depends on what the bank’s objective and what we wanted as a shareholder. The financial advantage of scrip dividend is not exactly apparent. After all, one can create a quasi-scrip dividend exercise by using the cash dividend to buy the bank’s shares in the open market. The brokerage and administrative fees are comparative small in terms of costs as they can be easily offset if we purchase the bank stock at prices lower than the stock’s conversion price. That said, it is still good to discuss about the characteristics of scrip dividend from the bank’s perspective as well as from shareholder’s perspective.

For the bank

  1. Generally, banks (or for that matter any public-listed companies) do not like to have too much volatility in their stock prices. Essentially, they want people with long-term views. By distributing dividends in the form of scrip, it helps, to a certain extent, make shareholders hold onto their stocks longer. For one, by providing scrip dividends that end up in odd-lots in the hands of shareholders. Thus, this makes it more difficult for holders to offload their stocks easily.
  2. By providing a discount to the on-going share price, the bank is, in effect, encouraging shareholders to take the scrip  dividend instead of cash. This helps the bank to preserve cash which can be very useful during times of need. Just base on the back-of-envelope calculation, with the dividend of 23 cents per share, it would cost the bank $979.1 million in cash for just this dividend distribution. Even though OCBC is able to meet the current Common Equity Tier 1 (CET-1) requirement, it still went ahead to offer scrip dividends. This may mean that the bank is forecasting uncertain times or it may be preserving a bigger war-chest of cash for some capital investment ahead. While attempting to preserve cash capital, it is, in effect, creating a larger share base. This will have a dilutive effect. It may work against shareholders especially when times turn for the worse. Fortunately, OCBC has been buying up their own shares in the open-market. The bank had been given the mandate in the last shareholders’ annual general meeting to buy up to 212 million (or 5% of the issued shares) in the open market. Certainly, as shareholders, we would be more comfortable with companies that are able to buy back their own shares compare those that are unable to.
  3. While the bank is dabbling in the stock market buying 200,000 shares each time, it is not possible to know whether the bank is gaining or losing out in this whole exercise. After all, their job is not to make a profit by buying shares in the open market. Based on the 5% buy-back mandate from the shareholders, the bank can buy up to 212 million shares. Given that OCBC makes a purchase of 200,000 shares each time, it would take more than 100 trading days to fulfill the whole order, and not including those purchasing shares under the employees’ option scheme. This translates to about 40% of the total number of trading days in a year. In some days, it may buy high and in some days it may buy low. Generally, the stock price during the conversion days tend to be very high as they are very near to the ex-dividend date. So, it means that the conversion stock price tends to be on the high side. So, even if  the bank gives a 10% discount over the conversion price, there still may a chance that the bank did not lose out buying from the open market as its average buying price can be much lower than the conversion price. As of today, the conversion price is yet to be determined. It will be the weighted average of the trading share price from 3 May 2019 to 6 May 2019 (Inclusive). Note that a cash dividend is a certainty for the bank. For scrip dividend, this is not certain as to how many shares will be ultimately distributed. With the sweeteners (discounts) for shareholders thrown in, it is yet to be known whether the bank gains or loses out compare to cash dividend. However, one thing if for sure. Less cash will be dispensed, but, at the expense of a larger share base.

Shareholders

  • As shareholders, scrip dividend can be an alternative to cash dividends if the shareholder does not need to the money at that time. The problem of going for scrip dividends it that we end up with odd lots. This can be a bit troublesome if we want to sell them in the future. Although lot size has been reduced from 1000 shares to 100 shares, stockholders are often forced to sell  the mother lots in order to amalgamate the sales due to the minimum brokerage charge.
  • As one may point out, there is no need to pay for brokerages and the other administrative fees when we accept scrip dividends in lieu of cash dividends. However, this often not a major issue. As it is, one can create a quasi-scrip dividend by buying the stock from the open market upon the receipt of dividends. The brokerage and all the related fees are relatively small, and can be easily offset if one is able to purchase at a lower trading price than the conversion price calculated by the bank.  
  • One point about scrip dividend is that we are able to practice what is known as power of compounding. Say we have 10,000 shares and the dividend rate is $0.23. Assuming a conversion rate of $11.50, we would be entitled 200 shares. The next time when OCBC declares scrip dividends, our share base would be based on 10,200 shares instead of 10,000 shares. As our stock accumulates, we are in effect, practicing the power of compounding. From that point of view, it is true. In essence, I am assuming that the future dividend distribution continues to be the same or higher. In investments, many unexpected things can happen. It is possible that the bank falls onto bad times and have to reduce the dividend rate. A decrease in the dividend rate can have a significant effect on the power of compounding.
  • Certainly, a discount in the conversion price of the scrip dividend is a plus factor to encourage shareholders to take up the scrip dividend. It provides an additional margin of safety. This stands as a cushion in a falling share price situation when the global economy or the business situation  for the company turns for the worse. It serves as a good alternative to getting cash dividends.

At the end of the day, there is no absolute advantage or disadvantage to either the bank or to the shareholders. It is more like a question of choice. As mentioned earlier, OCBC has the lowest payout ratio (41% compared to DBS’s 55% and UOB’s 50%.). Perhaps, it has been under pressure to bring up its dividend payout as well. Instead of increasing the dividend rate, it is probably doing so by increasing the share base so that the total payment ratio reaches the mid-40%.

Disclaimer – The above points are based on the writer’s opinion. They do not serve as an advice or recommendation for readers to buy into or sell out of the mentioned securities. Everyone should do his homework before he buys or sells any securities. All investments carry risks.

Brennen has been investing in the stock market for 30 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is the instructor for two online courses on InvestingNote – Value Investing: The Essential Guide and Value Investing: The Ultimate Guide. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.