In this weekly series titled JUST ASK, we invite readers to send in questions on stock investing, and personal finance. We will ask an expert (or experts) to provide answers. Below is a set of questions from a reader regarding cash-rich companies and whether they should be paying out special dividends. The answers are provided by Musicwhiz, a popluar blogger-investor, Value Investor, a professional in the investment community, and Ernest Lim, an investor with chartered public accountant and chartered financial analyst qualifications.
Reader: Hwa Hong Corporation, InnoTek & Lion Asiapac are among the companies which recently were in the spotlight for proposing/declaring high dividend payouts.
Their stock prices have risen sharply as a result, and their minority shareholders should be very happy.
a) Is a generous dividend payout something that companies should be doing if they have ample cash?
b) Under what circumstances is it better not to do so?
c) What Singapore-listed companies do you know of with ample cash but are not paying dividends that are significant, relatively speaking? Are they right in doing so, in your view?
Musicwhiz: Dear reader,
a) Companies should only pay out a "generous" dividend if they have nothing constructive to do with the cash. The reason for a cash hoard is to use it for M&A usually, but if nothing exciting comes along which will give high Internal Rate of Return or Return On Equity (ROE) then the Company is better off paying the cash back to shareholders so that they can invest it on their own.
Cash earns a very miserable 0.125% per annum, so most people don't mind getting it back so they can deploy it constructively.
Another way of looking at it is the Company pays out a "special" dividend to give X% yield based on the stock's market price, since it cannot deploy the cash to get a return higher than X% for shareholders. At least, that's how I see it.
Personally, I like cash-rich companies but I prefer it if they could deploy the cash for high ROE and good margin businesses.
b) I think I answered your question in (a) above! Basically, if a company can deploy the cash to generate above average returns (measured against inflation), then it makes sense to retain the monies instead of paying a special dividend.
The reason people get excited over a special dividend is, of course, the prospect of a "windfall", akin to hitting a jackpot payout.
But what shareholders may not realize is that had the cash been properly and prudently deployed into a good business generating Free Cash Flow with good net margins, the benefits can flow back to them in the form of increased dividends over an extended period of time!
c) This is a question which is not easy to answer directly. There are many companies out there with net cash, and their cash hoard makes up perhaps 30% to 50% of their share price per share, with some like GRP "hoarding" about 10.2c worth of cash per share when its share price is just 22.5 cents.
One must approach it from this angle - does the company have plans for expansion, or do they plan to eventually return the cash pile? If a Company has a cash hoard but are poised to use it for M&A or capex, then it will retain the cash (obviously).
Whereas, for a company like GRP, which are generating buckets of FCF, the cash seems to just build up for no particular purpose. In such cases, it may be better if the Company declares a special dividend to return some cash back. That's what happened for Lion Asiapac I think.
But a word of warning - be careful of companies which make dividend "guarantees" (I believe InnoTek did this when they said they are able to pay 5c per share consistently into the future).
A dividend is NEVER guaranteed and is contingent upon economic conditions, competition landscape and a myriad of other factors. To purchase a company with the prospect of increasing dividends is a dangerous game, as these are unpredictable and you may be over-paying for growth and cash which hasn't been generated yet! Instead, invest with the view (and expectation) that dividends will at least remain constant or even get cut so that you can temper your expectations and demand a margin of safety.
To know if a Company is "right" or "wrong" is not an easy task, as you would have to run the business yourself to really know that! What we can do, as conservative investors, is to ensure that the Company has a viable and sustainable business moving forward and that it can continue to generate FCF and pay out a decent dividend.
To me, hoping for a special dividend is a little like waiting for a rabbit to knock against a tree and fall dead (a Chinese Idiom); if it comes, well and good, but if it does not, you can fall back on the regular dividends.
- Musicwhiz is a 30-something investor who has been investing for about 5 years in the Singapore stock market. He practices value investing and does his own research into potential companies to invest in. He posts regularly on NextInsight's forum, and writes regularly on his blog http://sgmusicwhiz.blogspot.com/
Value Investor: Dear reader, the answer, in my opinion, paradoxically is: it depends.
Firms should retain cash for future reinvestment if management has a productive use for the capital in future. This usually is true for firms which are still in the early stages of their business life cycle. The converse usually applies to firms with mature businesses or operating in mature industries. In such cases, cash may be better off returned to investors.
Management's track record of being able to generate returns with retained cash can be approximated by the firm's Return on shareholder's equity (ROE).
If the ROE is high, management has and is likely to be able to do a good job of deploying the cash and hence will benefit investors in future. Otherwise, should ROE be mediocre, investors' interests would be better served by having the cash returned to shareholders who may be able to reinvest the proceeds for higher returns.
Firms may also need to retain cash if there are high future capex needs or if it is operating in a highly cyclical industry. In the case of the latter, having financial flexibility is paramount. Hence, retaining a cash buffer helps to cushion the firm in a downturn and can even allow management to make opportunistic acquisitions. So the nature of the firm matters.
- Value Investor is a 30-something professional in the investment community who has contributed articles to NextInsight, including:
* LION ASIAPAC: Stock's creeping up because .....
Ernest Lim: Dear reader,
Q1. Is a generous dividend payout something that companies should be doing if they have ample cash?
Ans: No. It depends on whether the company has better use of the funds.
Q2. Under what circumstances is it better not to do so?
Ans: Below are some of the circumstances which it is better for the company not to do so:
a) Requires to make outstanding loan repayments;
b) Substantial capital expenditure;
c) Merger and acquisitions and investments in companies;
d) Buffer against bad times. For more information on the above, do refer to my article on http://www.sharesinv.com/articles/2010/03/16/cash-hoard-boon-bane-sharesholders/
Q3. What Singapore-listed companies do you know of with ample cash but are not paying dividends that are significant relatively speaking? Are they right in doing so, in your view?
Ans: For example, China Sports and China Gaoxian have ample cash but are not paying dividends in their 4Q09 results release. (FYI, China Gaoxian paid a S$0.0066 dividend per share during its 1H09 results but didn’t pay another dividend in 4QFY09 results, despite ample cash) I have briefly listed down their use of funds. Only time can tell whether they are right in doing so.
China Gaoxian China Gaoxian has RMB598m of cash as at 31 Dec 09.
It intends to spend an approximate total of RMB300m CAPEX in FY10 to:
a) increase its yarn production capacity from 180K metric tonnes to 241.5K metric tonnes and
b) expand its fabric production capacity from 17K metric tonnes to 81K metric tonnes. For Gaoxian, results should start to trickle in 1HFY09 but more apparent contribution should be seen in 2HFY10 and beyond.
China Sports China Sports has RMB902m of cash as at 31 Dec 09. It intends to spend between RMB375m and RMB535m in CAPEX in FY10 for the following uses:
a) Between RMB150 million to RMB180 million for the construction of new plant;
b) Approximately RMB30 million for the construction of multi-complex;
c) Approximately RMB50 million to RMB100 million for the expansion of YELI specialty stores;
d) Approximately RMB30 million to RMB50 million for promotion and advertising of YELI products;
e) Approximately RMB115million to RMB175 million for setting up distribution network for FIFA related products and provision of renovation subsidies as well as furniture and fittings to the distributors for setting up FIFA modular stores, FIFA specialty stores and Official Event Stores.
For China Sports, results should be seen in FY11 and beyond.
- Ernest Lim previously worked as an assistant treasury and investment manager, and is now in between jobs. He onced worked for Legacy Capital Group Pte Ltd, a boutique asset management and private equity firm, as an investment manager. He received a Bachelor of Accountancy (Honours) from Nanyang Technological University in 2005. He is a Chartered Financial Analyst, as well as, a Certified Public Accountant Singapore.
