MONDAY MACRO: Investors use this strategy to avoid price volatility — let’s see how they’ve done since last year’s market selloff
Last week, the Philippine Stock Exchange Index (PSEi) opened on a weaker note amidst growing concerns over the health crisis, before recovering a bit as President Duterte lifted a moratorium on new mining deals. As a barometer for the Philippine economy, the PSEi serves as a great indicator for investor interest in the Philippine market.
With pandemic-related headwinds pressuring the Philippine market into a recession, this chart shows one way to outperform the barometer.
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In the early 17th century, the Dutch East India Company became the first company to issue shares to the public–effectively an IPO–and to regularly issue dividends to investors.
Through the issued shares from the IPO, the company was able to gather enough capital to venture and trade goods to Asia, while giving investors the chance to profit in the trading business.
This new source of funding was important since shipping goods from Europe to Asia at the time had unpredictable risks such as piracy, untreatable diseases, and violent storms that endangered shipment safety.
The profits of the venture were divided among the investors through issued dividends, paying an average annual dividend of 18% until its dissolution in 1800.
Even though the company was known and regarded for its size and power, issuing dividends regularly to their investors is one of their well-known contributions that is still used to this day.
The word ‘dividend’ is known to have originated from the Latin word “dividendum” which means to be divided.
In modern finance, dividends are shares of a company’s profit paid out in cash or stock to shareholders.
Cash dividends are the most popular type of dividend payout. Depending on the company’s financial performance and growth opportunities, paying cash dividends can signal either stability or a lack of investment opportunities.
There are three main dividend policies companies can use: stable dividend policy, constant dividend policy, and residual dividend policy.
Companies that use the stable dividend policy pay out fixed dividends each year regardless of financial performance. Investors that enjoy receiving a predictable payout prefer this arrangement.
Companies that decide to pay dividends based on their financial performance use the constant dividend policy where the dividend payout in a year is calculated as a percentage of earnings. Investors will see a dividend payout increase in excellent years though they may not receive dividends during down years.
Finally, companies that choose the residual dividend policy pay dividends only when there is excess capital after paying all their capital requirements. This makes sense to investors that want to participate in a company’s growth without worrying about the company potentially destroying value just to be able to pay dividends.
Since it’s management’s discretion to issue dividends to shareholders, not all companies pay dividends.
Companies have the choice to either reinvest their profits to grow their business or divide their profits among shareholders. Furthermore, constantly issuing dividends to investors can limit management’s use of capital, forcing management to be more selective in their spending because dividends are huge cash commitments.
This is why a lot of mature companies with sustainable profits are more likely to pay dividends. Moreover, stable, mature companies have the ability to withstand economic shocks, thereby reducing the risk of excessive stock price fluctuations.
Let’s take a look at how the top 30 Philippine companies in terms of dividend yields did since the market selloff early last year.
In the chart above, the performances of the top 30 companies with the highest dividend yields and the PSEi index were measured by compounding changes on a daily basis.
At the start of 2020, we can see the prices of the index and these 30 companies closely trended together. However, by mid-March 2020, during the pandemic-induced market selloff, the PSEi fell much farther.
By April 2020, both groups were able to regain their footing, but while the high dividend yield group was able to rise above their pre-pandemic prices, the index has continued to struggle below.
More importantly, however, the basket of high dividend yield companies saw lower price volatility compared to the index, which has experienced numerous price fluctuations since May 2020.
We mentioned in one of our Friday Uniform Portfolio Analytics reports that fund managers utilize this dividend investing strategy in the hopes of generating income and capital appreciation.
However, investors still need to be cautious when employing this strategy. As mentioned earlier, some companies with higher dividend yields may also have lower growth potential. Companies with growth opportunities tend to reinvest their profits in R&D or capex spending.
With dividend policies being subject to economic and company-specific headwinds, it is important to note that there is no guarantee that companies will always issue dividends in the future.
Even in the 21st century, businesses are still exposed to unpredictable risks that pressure the market downwards. Nonetheless, strategies like investing in high dividend yielding companies are great ways to mitigate these risks as investors can avoid price volatility, especially in down markets.
About the Philippine Market Daily
“The Monday Macro Report”
When just about anyone can post just about anything online, it gets increasingly difficult for an individual investor to sift through the plethora of information available.
Investors need a tool that will help them cut through any biased or misleading information and dive straight into reliable and useful data.
Every Monday, we publish an interesting chart on the Philippine economy and stock market. We highlight data that investors would normally look at, but through the lens of Uniform Accounting, a powerful tool that gets investors closer to understanding the economic reality of firms.
Understanding what kind of market we are in, what leading indicators we should be looking at, and what market expectations are, will make investing a less monumental task than finding a needle in a haystack.
Hope you’ve found this week’s macro chart interesting and insightful.
Stay tuned for next week’s Monday Macro report!
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