Let's do a quick recap of what we have gone through in the last session. We talked about the types of dividend companies that investors like to have in their dividend portfolio. We also learned about the different types of returns to expect the dividend paying process and what to do with the dividends you receive, when to reinvest and when not to reinvest. In this session, we will be analyzing the dividend companies themselves. This is an overview of what we will be going through investing in dividend companies and filtering for them. Please take a moment to read the disclaimer as I prepare to set things up.

Alright, so in this session, there will be two major portions. The first portion is about investing in dividend companies. The objectives for this course is to help you recognize common misconceptions about investing in dividend paying companies and understanding key financial ratios. What are they? How are they classified and how these ratios are involved in screening for good dividend companies. Once we are done with the first portion, we move on to the second one filtering for dividend companies.

Under this portion we will dive deep into the application process screening for dividend sustainability stocks, dividend growth stocks, conducting assurance research and qualitative research. All the good stuff anymore. So, without further ado, let's start common misconceptions about investing in dividend companies. If you attended the Reed's masterclass, you probably know quite a bit about the misconceptions that investors make when investing in REITs. This section has similar concepts but applied to dividends. Stocks instead of reeds.

It is always good to recap them as conceptions so as not to fall prey to them when you put your hard earned money into the market. So the first misconception about investing in dividend companies is when screening for dividend companies. Green horn investors usually pick the highest paying or highest yielding dividend companies. I know that results matter and it is easy to be attracted by companies that pay the highest dividends. But the danger here is assuming that the best companies are the ones that give the highest dividend yield. For example, a company that gives a dividend yield of 8% is considered better than another company that gives a 4% yield.

Studies have shown that a portfolio of companies with the highest dividend yields tend to underperform the broad equity market. For example, and this picture between 1992 and 26 It shows that the companies with the highest dividend yield historically did worse than the broad equity market, and the lowest yield quintile on a total return basis. total return basis means dividends and capital gains included. I'm not surprised to see such results because often when I screen for only high paying dividend stocks, I studied the list of companies in detail and find that many of the companies on the list either are in some sort of financial trouble or have weak cash flow and balance sheet health. Therefore, for a high paying dividend to be worth your time, you have to also consider its sustainability factors such as free cash flow, level of debt, shrink of their balance sheet and so forth.

I will provide more details on this when we touch on the topic called dividend sustainability mandates. For now, remember that if one investment is paying 8%. When similar investments are paying less than half, there might be something wrong, and this will require further investigation. Read the prospectus and the financial statement, find out how the company generates those high dividends because if the money isn't coming from profits, it's coming from selling off assets or worse taking on debt. Now, for the second misconception on dividend investing, many investors even the experienced ones tend to assume that consistent dividend paying companies are low risk and safe. They would simply screen for companies that have been paying dividends consistently for the past five or 10 years, applying the shortcut, adding these companies into their portfolio and calling it a day.

For someone who loves such companies and have benefited tremendously from this focus on dividend consistency strategy, I must say it takes more work. effort than simply screening for dividend consistency. Before 2014 there were lots of dividend paying oil and gas related companies. They fit the criteria of being a dividend investors dream for being consistent with their payout for so many years. But as of today 2018 the oil glut and the rise of shale oil wasn't so kind to many of these consistent dividend paying oil companies. Their share price decline probably wiped out whatever dividends was collected over the many years.

This is similar to 2009 real estate and financial stocks, which for a long time had paid very reliable dividends ended up going into a tailspin. So no matter how you look at it, investing is risky. If you want to engage in dividend investing, do it right, put in the effort because there are no shortcuts for quality screening. The third misconception not understanding the purpose of each type of dividend investments. For example, dividend paying stocks are used as a substitute for bonds. Some investors believe they can improve their yields without taking additional risk by relinquishing bonds from their portfolio and substituting higher dividend paying stocks.

Under portfolio management best practices. This is a big no no. This is because dividend paying stocks are equity by nature. And just like equity investments, dividend paying stocks might not hold up when the market declines. They have significantly greater risks and high quality short term bonds. Comparing the returns of these two investments.

It's like comparing apples to oranges, it isn't logical. The purpose of bonds is to lessen periods of volatility, so treat them differently as they have their own function and purpose in your dividend portfolio, do not substitute them with dividend paying stocks. Now we move on to the key ratios and their implications. dividend investors are always on the lookout for the best dividend stocks to switch or hold for the medium to long term. In this section, I'll talk about the basics of ratios and why dividend investors use them to filter out better dividend companies and other investment opportunities. financial ratios can be broadly classified into profitability ratios, liquidity, solvency and cash flow ratios including other minor ones.

Let's take a close look at profitability ratios. The profitability ratios are ratios that measure the ability of a business to earn profit for its owners. Important profitability ratios include Revenue patterns, operating profit margin, net margin earnings per share, and I will go through each of them. All right ready? revenue pattern. The reason revenue patterns are so important for dividend investing is because they can inform us whether the company's products and services are in demand.

Some companies can temporarily increase net income without revenue growth simply by cutting costs, but there is a limit as to how much costs can be cut. Eventually, the business must sustain or grow revenue, if not their business model profitability will come into question. So what kinds of revenue patterns do we as dividend investors look out for? Let's look at a hypothetical company company x as an example, company x lists and manufactures a wide variety of steel products. Here is their revenue pattern history. As seen here company x is sales of steel product fell by 53% in 2011, fell again in 2016 and recently in 2017.

A quick look at these revenue figures shows that company x might have little control when it comes to growing its business because it may be extremely sensitive to the price of steel. Would you like such a business to be included in your dividend portfolio highly unlikely. Then on the other side of the coin, we have promising dividend companies like Becton, Dickinson dy dx, which has consistently churned out relatively stable revenue growth even throughout the last recession. Not surprising, as the health care company sells a number of essential medical devices and systems that are needed in practically every economic environment. dividend investors would love to have companies that manage their cost well and produce steady your earnings. But how about companies that are cyclical by nature, or companies that earn their profits via projects and contracts.

Although these businesses do provide good dividends to investors for certain periods, their revenue and net income patterns are erratic, and their dividend payout will be as well. To succeed in capturing dividend paying cyclical companies, you need to be skilled in timing the business cycle. Buying a cyclical company at the top of a cycle is one of the easiest ways to lose a lot of money quickly. But for a start, if you're new to dividend investing, or don't have the time to track your investment, just avoid companies with sales that are volatile or have been falling. The next two ratios are operating profit margin and net margin to obtain a company's operating profit margin Divide its operating profit by its total sales. operating profits generally represent the company's earnings before interest in taxes.

And to obtain a company's net profit margin, divide its net profits by its total sales. net profit margins show how much of each dollar collected by a company as revenue translates into profit. Let's talk about operating profit margin first. by excluding these interest and tax expenses, we can compare companies regardless of their financing choices and tax treatments to focus on the profitability of their actual operations. Here's some extra information after my team and I have observed more than 500 dividend growth stocks, the median operating profit margin is set to be about 12%. But the main point here is that a true track record of growing or stable operating profits is a testament to the strength of the company's economic moat.

This also applies to the net margin as a company's profits are an important source of its dividends. And as we know, profit is what is left when we deduct a company's various costs from its revenue. But can there be a case where the operating margin of a business is negative, but its net profit margins are positive? The answer is yes. This is due to selling of investments or income coming from interest and other investments. The profits might not come from the main business and likely could be one offs.

That is why we need both margin ratios to be included in the screening process. Another alternative to net margin is using operating or EBIT margin. These two ratio measures are somewhat similar. They're different Is are minimal and not crucially important to individual investors who are reviewing financial statements as part of their fundamental analysis. I mentioned this because when we go on to the next portion portion two, which is about screening for dividend stocks, some screening platforms might just provide either one of these ratios. Knowing that operating margin and EBIT margin are similar makes the screening application easier.

Earnings per share EP s earnings per share EP s growth is another ratio to consider. epcs takes the net income divided by the number of shares outstanding. The EBS growth ratio can give us insights into whether a company is issuing shares or repurchasing them. For example, looking at the formula, if the company's earnings are stable or slightly declining, and yet the GPS is increasing. Then the company is Probably repurchasing shares. In any case, a persistent negative EP s growth or negative average APS growth rate is not desirable, either the earnings are decreasing or the number of shares is increasing, which is share dilution.

Hence, we must be careful not to only look at a company's single year's EP s performance, but also its average NPS growth. Because even if minority investors are excluded from funding this special project, the latter still must be profitable or accreta eventually, hence, the average EP s growth figure captures this notion. Now for liquidity ratios. liquidity ratios assess a business's liquidity, ie its ability to convert its assets to cash and pay off its obligations without any significant difficulty. Important liquidity ratios are Current Ratio and cash conversion cycle. Oh, do know that the formulas will be provided in the section course attached, so you don't have to memorize them or write them down.

Okay, so back to the current ratio. This ratio is determined by dividing current assets by current liabilities. The current ratio measures whether or not the company has enough resources to pay its debts over the next 12 months. By rule of thumb dividend investors should be concerned when their company has a current ratio but is less than one. This means that current liabilities exceed current assets. The company's ability to meet short term debt obligations comes into question, as many potential and existing creditors use this ratio in determining whether or not to make short term loans to the company.

But do take note that different industries have their own acceptable current ratios. For example, most us industrial companies a 1.5 Cr is an acceptable current ratio, whereas the airline industry a CR of below one is still acceptable. This is because there is usually sufficient cash flow from advanced booking of air tickets. Hence, their current liabilities remain higher than their current asset. So, if a company can turn their inventory into cash much more rapidly than their accounts payable become due or there is sufficient advanced cash flows to be expected, then a car of less than one is acceptable. Speaking about how rapid a company can turn their inventory into cash, the ratio to measure this rapidly This is called the cash conversion cycle.

The formula is as such cash conversion cycle equals DSO plus DIO minus d p o DS O stands for days sales outstanding, which equals to average accounts receivable multiply by 365 divided by sales on credit. Di O stands for days inventory outstanding which equals to average inventories multiply by 365 divided by cost of goods sold. And DPO, which is days payable outstanding equals to average accounts payable multiply by 365 divided by cost of goods sold. cash conversion cycle is another important ratio for dividend investors, particularly when investing in dividend companies that carry significant inventories and have large receivables because it highlights how effectively the company is managing its working capital. Working Capital here means the amount of money needed to keep a business's day to day operations afloat. calculated as the current assets minus the current liabilities.

Generally short cash conversion cycle is better because it tells that the company's management is selling inventories and recovering cash from those sales as quickly as possible, while at the same time paying the suppliers as late as possible.