Sonia Rehill hosts episode 6 of Ask A Foolish Question.
The Motley Fool's Sonia Rehill delves into her mailbag for another batch of your investing questions in this episode of Ask A Foolish Question podcast. Sonia is joined by David Kuo, who is on hand to answer a raft of queries about dividend investing that include whether it is better to 'Dividend Re-investment Plan' (DRiP) into the same company or dribble the money into a different share.
They also look at liquidity problems when buying and selling shares, the roles of a chairman and a chief executive officer in a company, and the intriguing issue of reverse splits. If there is a question about investing that you would like answered, please email Sonia at foolishquestions@fool.co.uk.
You can download or listen to this podcast here.
Sonia:
Welcome to Ask A Foolish Question, The Motley Fool's podcast dedicated to help answer all your investing questions. I'm Sonia Rehill, and back in the Mastermind chair is David Kuo for our sixth episode. Hello, David.
David:
Hello, Sonia, I hope I get more than one point.
Sonia:
Well, it depends on how you answer all the questions.
David:
OK, I'll try and do my best.
Sonia:
OK, so as usual, David, I have lots of questions to get through today. My inbox is full of questions about dividends, investment trusts, reverse splits and the use of leverage, so shall we get started?
David:
Yep – I can't wait.
Sonia:
My first question is from Mo, and it's about his dividend jumping investment strategy. He is planning to invest £10,000 just before each ex-dividend date in all his share purchases. When the shares bounce back to just slightly over his buy-in price, he intends to sell and jump into another share with an ex-dividend date ending soon. He intends to buy shares returning a 5% yield, either mid- or end-year. Could he do this four times in one year, allowing three months' recovery time, generating a total compound return of possibly 22% in one year? Is his strategy flawed?
David:
Well, my question is, how do you know that the shares are going to recover? It would be nice if the shares did recover, but as we knew from previous podcasts, what happens is, the share price will fall after the dividends have been paid, and it can take a whole year before the share price does recover to where it was before. So I don't fully understand how this strategy is going to work. It's almost as though Mo is saying that he can time the market somehow, and I think that is quite difficult to do. Most people buy income shares, dividend-paying shares, for the dividends, and I would be much happier to just carry on doing that, rather to try and somehow outsmart the market.
Sonia:
Next up is a question from Steve. He would like you to explain the rules regarding ex-dividend date, and dividend payment for shares. So if he buys a share at least one day before the ex-dividend date, holds that share for the day it goes ex-dividend, and then sells it the day after it goes ex-dividend, will he receive the dividend payment on the payment date, or must he hold the share until the dividend record date? Is there a minimum time for which he must own the share?
David:
OK, it's a great question, Steve, and what you have to ensure is, you were absolutely right – if you buy the shares before it goes ex-dividend, you are entitled to those dividends, but what you must also make sure is that your name is on the register on the day that it is recorded, which is why it is called the record day. You must ensure that your name is on that register, because otherwise the registrar will just simply pay the dividends to whoever owns the shares, and if you don't own the shares, well, the dividend will go to somebody else. Now technically, that somebody else should pay you those dividends, because he has bought them without the dividends, but unfortunately, in some cases, whoever holds the shares may not actually notify, and say I'm not entitled to these dividends. So in terms of whether or not there is a minimum time for which he must hold the shares, the answer is, of course, you must ensure that your name is on that register. So there is no minimum time, but check on the company's web page, and it will tell you when the ex-dividend date is, when the record date is, and when the payment date is, and make sure that your name is on that register on the record day.
Sonia:
Next we have a question from Daniel. He wants to know, what is a good dividend payout ratio? He is putting together a solid dividend-based portfolio for his mother, and would like some guidance on what he should be looking for when he's doing his research. He mentions that Scottish & Southern Energy (LSE: SSE) has a payout ratio of 405 – is this too high? David, before you answer Daniel's question, can you explain what a dividend payout ratio is first?
David:
OK, no problem. A dividend payout ratio, and the inverse of the dividend payout ratio, is what we call the dividend cover, and it is a measure of how much of the company's profits are being paid out in the form of dividends. What you want to find is that the company has actually got more profits than it pays out in dividends, because otherwise those dividends are not coming from current profits, but coming from historical profits (the profits that the company has made in the past). Now, to work out the dividend cover, you take the earnings per share, and you divide it by the dividends per share, and the kind of figure you want to be looking for is around two; in other words, the company should be making more profits than it pays out in dividends, so it can actually retain some of those profits for growing the company itself. Now, in the case of Scottish & Southern Energy (SSE), what I actually found was that the dividend cover is 1.4, which is kind of OK. But in terms of the 405 that Daniel refers to, I can't quite sort of make head or tail out of 405.
Sonia:
Daniel, if you want to go and check where this figure of 405 has come from, and send us another email, we'll be happy to look at it again for you.
David:
Absolutely – I would be more than happy to have a look at that figure.
Sonia:
Great. My next question is from Tom, he is a new investor, and asks, what would be a good foundation of stock dividend ETFs and bond ETFs to put in his portfolio?
David:
OK, well I guess a good place to start would be to have a look at the iShares, because these are exchange-traded funds which you can buy and sell like shares, and you can find both dividend ETFs and also bond ETFs there. But what I would suggest, in the case of Tom, is, yes – by all means buy a couple of these ETFs, particularly the dividend ETFs and also the bond ETFs, but try and augment it somehow with some of your own selections, so that you have the core, which is the ETFs, but then add something on top of that, by having a look at some good dividend-paying stocks as well.
Sonia:
Speaking of iShares, David, my next question is from MB. He has invested in two iShares: the iShares Stoxx Select Dividend 30 (LSE: IDVY), and the iShares FTSE Dividend Plus (LSE: IUKD). He is reinvesting dividends in both, but each is showing nearly a 40% capital loss. He's hoping that the dividends will help overcome the loss, but has not seen much improvement for a while now. He can afford to continue reinvesting the dividends, but asks if this is wise?
David:
OK, I think it is wise to carry on doing that, but this actually links quite nicely with that previous question we had, in which if you are building a high-yield portfolio, yes, by all means have some of those iShares in there, particularly the dividend-paying iShare ETFs, and also the bond ETFs, but at the same time add a couple of shares yourself, so that you augment that portfolio and you're not totally reliant. Now, with regards to why his dividend ETFs have fallen by 40%, part of that reason is because ETFs are mechanical; in other words, the person who's constructed the ETF will just simply say, I want the 50 highest-paying stocks in the FTSE 350, and I'm not going to do a great deal of research, because these are just simply the 50 highest-paying stocks. Unfortunately, and I'm presuming that when MB bought these dividend-paying stocks, it was when some of the highest-yielding companies included the banks, and I'm thinking here of Alliance & Leicester (LSE: AL), Northern Rock, HBOS, the Royal Bank of Scotland (LSE: RBS) and maybe even BP (LSE: BP). So when all of these companies fell out of the index, that was what caused this capital loss, but as far as the long-term investor is concerned, the dividend yield on some of these ETFs at the moment is going back up again to 5.5 to 6%, so carry on re-investing those dividends, because the exchange-traded fund will just refresh itself.
Sonia:
Now, our final dividend-related question is from Richard. "Can you tell me if it is better to use DRiP to re-invest the dividends back into the same company, or use the dividends to add to what you would invest in the next purchase of a different share?"
David:
OK, that really sort of depends on how you want to construct your portfolio. DRiPs are a great way of reinvesting the dividends in the same company, but, as an investor, you might say, I don't really want any more of this particular share, in which case what you would do is to say, instead of taking the shares, I will just simply take the cash, and if you have a nice, large portfolio, what will happen is that all of these individual cash dividends that you're receiving will form a little pot of money, and then you can decide how you want to allocate it, which is my preferred way of re-investing dividends. Of course, I have DRiPs, but I also have a pot of money which is accumulating over a period of time, and then I can say, I don't want any of these ten companies that I've got – I want to invest in a new company, and with that pot of money, I can do so. But if you just simply opt for DRiPs, then you can't.
Sonia:
My next question is from Brian, and it's about the use of leverage. He says, "Good, bad or evil? – a tool to boost returns and dividends – how much is too much?" If he can borrow via CFDs at 2.5%, and get a 5% plus dividend, should he borrow as much as he can?
David:
Well, you know, Sonia, here at The Motley Fool we don't encourage people to borrow money to invest, and so therefore, with regards to his first question, good, bad or evil, I'm going to say, evil. What you should really do is to invest with money that you can afford to put away for five or ten years, and you don't really want to be borrowing money. It is very difficult to borrow money in order to invest. Now, in this particular case, you're borrowing money at 2.5% to get a 5% dividend – well, my big worry here is, what would happen if the shares were to fall? You would then cash out of those shares, you would still have to repay whoever you borrowed the money to, in which case any of the gains you think you will have made could be wiped out by the capital loss. So I wouldn't really encourage anybody to go down that route.
Sonia:
My next question is about investment trusts. It's a question from John – he is considering purchasing investment trusts, possibly City of London, and has read that one of the risks of investment trusts can be a lack of liquidity. Because he doesn't fully understand why this is the case, or the implications, he is deterred from making a purchase. David, can you explain why investment trusts can have liquidity issues, and the impact that that this can have on small investors?
David:
OK, it's not just investment trusts that John should be worried about in terms of liquidity, and for those people who don't know what liquidity is, it is how freely traded those shares are on the stock market. Now, if I were to buy shares in a small AIM-listed company, where only a handful of trades are going through every day, when it comes time for me to sell, who is going to be buying those shares? In a similar case with this investment trust, the City of London Investment Trust is a trust that is traded on the stock market, so therefore when it comes time for me to say, I want to get out of this investment trust, I want to sell those shares, who is going to buy it from me? – and this is where the liquidity issue comes in. But I've had a look at the liquidity for City of London Investment Trust, and it doesn't look that bad, but you're absolutely right – whenever you're making an investment – yes, by all means have a look at the share price, the buy and the sell price, but also have a look at liquidity, because if you can't sell, then what will happen is that the spread between the buy and the sell price will start to widen, so therefore, even though you think you might be making a profit, when you want to try and sell those shares, because nobody wants to buy them, then of course the purchase price, or whoever wants to buy them from you, may actually start to drop, so therefore you might not make as much money as you think you would.
Sonia:
OK, so we have to more questions to wrap up – some nice quick ones, David. What is a reverse split?
David:
OK, do you know in previous podcasts, we talked about when we had a share split, and I used the example of a £10 note, and asking you to give me two £5. Did I give you back the £10, by the way?
Sonia:
No, you didn't.
David:
OK, well I owe you £10 then. Right, I'm going to do something slightly different this time. I am going to take 10 ten pence coins, right? Here I have ten 10p coins. I'm going to give them to you, and in exchange for that you give me a pound. What I have done is, I've engineered a reverse split. I've taken 10 ten pence coins, and in exchange for that, you've given me a pound. Have I made any money, Sonia?
Sonia:
No.
David:
Have I lost any money?
Sonia:
No.
David:
There you go – you see, I don't like to lose money. So what I have actually done is, I've engineered a reverse split of my ten 10p coins. Now, many companies on the stock market like to do that, because what they say is, if I have a 10p share that's trading on the stock market, people will think, oh – this must be a rubbish company, because the shares are only 10p; especially if you have a big company whose shares are only around 10p, they don't like it. So what they will do is, they'll engineer a reverse split, and what they will say is, we'll take ten shares, and we'll convert those into one. Now, if ten of those shares were ten pence each, that share now becomes a pound, but as far as the market is concerned, I now have a one pound share on the stock market, rather than ten 10p shares on the stock market. So it is a perception that some companies have, they don't like to have cheap shares on the market. Now, one business that did this recently was Royal Bank of Scotland. Its shares were on the stock market at around 23, 24p, and you don't really want Royal Bank of Scotland shares trading on the London Stock Exchange, in the FTSE 100 (UKX), at 23p a share. So what they did was, they engineered a ten-for-one split, so they took ten of those 23 pence shares, consolidated them into one share, and now Royal Bank of Scotland is on the stock market at £2.30, which looks a lot better than having a 23p share for a FTSE 100 bank. The bank just simply didn't like the fact that its shares were just perceived as being cheap penny shares.
Sonia:
OK, and now for my final question, David – what is the difference between the roles of a chairman and a chief executive of a company?
David:
OK, now that's a great question, because some people think the chairman and the chief executive are one and the same, but it's not. The chairman is the chairman of the board of directors, who is there to look after the interests of the shareholders. Now, the board of directors can hire or fire the chief executive. If they want to hire a new chief executive, what they will do is, they will invite various people who'll have the capabilities of running a company to come and put forward plans as to how they wish to run that particular business, and if they like the sound of a particular chief executive's strategy and plans, they will say, you are hired to run that company. So the chairman and the board of directors, the chairman as the head of the board of directors, will appoint the chief executive, and it is up to the chief executive to make things happen, and if it doesn't happen, then of course the chairman can say, you are not doing your job properly, and we need a new chief executive.
Sonia:
I've got one more question for you, David.
David:
One more question – I thought that last question was the final question, Sonia!
Sonia:
This is the final, final question.
David:
OK, right – I'm ready for it.
Sonia:
So David Holding has written a very interesting article on our website, on fool.co.uk, in which he asks: "If you could only own one share for the rest of your life, which would it be, and why?"
David:
Oh, that's a nice easy one, Sonia. I thought you were going to give me a really tough question to end on.
Sonia:
No, I'd never do that.
David:
That's true, that's right. So anyway, the one share that I would own is Unilever (LSE: ULVR). I have been a Unilever shareholder since about 2000, which means that I've been holding its shares for over 12 years. I've been absolutely convinced that this is a company that will last almost forever. Just have a look at your kitchen cupboards – just see how many Unilever products there are. Just have a look at your freezer – see how many Unilever food products there are. This is a company that carries on paying a dividend, it keeps on growing, it keeps on rejuvenating itself. Yes, it will have its ups and downs, but it is a company that just keeps on going on and on, which is why I am a Unibeliever, Sonia.
Sonia:
Wonderful – you are a Unilever Unibeliever, David!
David:
I am Unilever Unibeliever – you're absolutely right!
Sonia:
Great, well thank you so much for all your answers.
David:
You're welcome, Sonia.
Sonia:
We'll be inviting the Unilever Unibeliever back onto Ask A Foolish Question next time. If you have an investing question you would like us to cover next time, please email me at foolishquestions@fool.co.uk, and if you would like to listen to previous episodes of Ask A Foolish Question, go to fool.co.uk/podcasts, where you can also read the transcripts.
Thanks for listening, and until next time, happy investing!
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> David owns shares in Unilever. Both David and Sonia owns shares in BP.
