Posted on March 18, 2009 - by Market Uncle

Yield Investing versus traditional Value Investing

Photo by Lachlan Hardy

Motivation

No one doubts that the current economic crisis is one of the worse the world experience since the great depression in the 1930s. However, the silver lining is that it brings one of the greatest investment opportunities too. I remember $20,000 is not even sufficient to buy one lot of DBS or UOB, now this same amount can buy one lot each of DBS, UOB and OCBC (with some to spare if not because of the rally on friday).

I had wrote before that market price always lag (not lead) fundamental changes. Even though stock market are generally forward looking, and can stage a sustained rebound months before the real economy turn around, fundamentals must improved first before that happens. But I have yet to see any improvement in fundamentals. Many companies, across varying industries, are either seeing substantial drop in profits or making losses (due to heavy overheads or intangible asset write-downs).

Thus, other than waiting and grabbing shares of firms going way below their (deteriorating) fundamentals, is there any alternatives?

Yield Investing

I began to toy with a new the idea after I bought in First Ship Lease Trust (FSLT) and Cambridge Industrial Trust (CIT). Despite the volatility (generally downwards) of their share prices and that of other shares in my portfolio, both paid generally consistent and substantial dividends. I recall my target cost of capital was about 15% compounded annual returns, so that I can double my investment approximately 5 in years. Both could easily exceed this expectation solely on dividend payout (even after factoring reduced payouts).

Given the uncertain economic outlook, spare cash might not be easy to come by as I need to set aside cash for more rainy days ahead (thus no longer money I can afford to lose). My source of funds to grab bargains shrunk substantially as a result. Fortunately my quarterly dividend income come in nicely to fill the gap.

As a result, why don’t I increase my dividend yielding equities using whatever limited spare cash I can squeeze and use the regular payout to fund my bargain hunting on good businesses going below their value? Unless there is a specular recovery of the share prices of all companies across the board, I am sure the dividend income will come in time to grab a few still neglected by the market.

Criteria for Yield Investing

Not all high yielding equities (predominantly Business Trusts such as REITS and Shipping Trust) are suitable for yield investing. There are a few criteria to meet which are derived from the objective of yield investing:

To provide sustainable, regular, and frequent dividend income.

Thus the criteria are:

1. Low volatility in business revenue, cash flow, payout policy and consequently payout, i.e. distribution per unit (DPU)
2. Simple and understandable business model
3. Sustainable business model
4. Relatively high yield (>20%)

FSLT and CIT easily met the 4 criteria with their clear and simple business model (buying assets and lease them on long term binding contracts) and sustainable DPUs. I was tempted to just invest in FSLT given it’s current yield is in excess of 40% but I had to be rational and act with prudence. I need to diverify to ensure a sustainble and regular dividend income stream.

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