Asset Management
Part 4
Part 4
Whilst it is tempting to set an arbitrary benchmark for our minimum income of say 15%p.a., it would probably be an unrealistic approach given that the average dividend yield of the entire stockmarket has a very strong tendency to track official interest rates. In other words, our expectations in terms of income must remain flexible and in keeping with the Reserve Bank of Australia's official cash interest rate.
As the average dividend yield is usually just below the official cash interest rate we will set our minimum benchmark at the RBA's official cash rate (www.rba.gov.au). This will ensure that our income stream is always above the official cash rate and we're always ahead of the curve.
What's more, this benchmark doesn't take into consideration any franking credits (tax credits) that we may also be entitled to. Be aware that whatever benchmark we choose to employ is only our starting point and should reflect our tolerance towards minimum income. As explained in an earlier article, using the example of CBA shares bought in late 1991 for $6.50, our assets will gradually mature over time. The income streams from these assets will grow in magnitude and proportionality with respect to the prices we originally paid for them. For example, if you paid $6.50 for CBA shares in 1991 then the annual dividend of approximately $2.50 per share represents an annual income stream of 38% with respect to your original purchase price whilst it only equates to a dividend yield of approximately 4.5% with respect to the current price of CBA shares. So if we were to apply a minimum benchmark of let's say 4.75% to the dividend yield of Blackmores, we can see that it would exceed our expectations in terms of income requirements.
The dilemma we now face is 'Do we buy today or, given that the share price is currently falling, do we wait for a possibly higher income yield in the future?'. The answer is…we buy if the current dividend yield is above our threshold and we continue to accumulate shares into the future if the share price continues to fall. Whereas traders will cry foul because we're averaging down our purchase price, a no-no when trading, we are in fact averaging up the dividend yield.
It is also interesting to note that when we are accumulating shares in a particular company, while the share price continues to fall, we could in fact be losing money. In other words if we add the dividend payments to our capital losses, the result is a negative one. But given our timeframe of a 'Lifetime', these losses are just the short term impact of an imperfect market entry. Fund managers will often use similar reasoning as an excuse for losses but it is only a valid excuse if their timeframe is the same as ours and they are accumulating income streams.
On a final note on income, it is always wise to ensure that the 'Dividend per share' or DPS is not of an abnormal nature and is in keeping with the normal dividend payment pattern of the company. In other words, check that the company has not paid out an extraordinarily large dividend because it's income has been abnormally inflated due to a unique circumstance such as the selling of a major asset. An example of this is when Mayne Nickless sold its interest in Optus many years ago which led to a bonus payment to shareholders of an extra $1 per share.
The benchmarks we have set are tough and we haven't even begun to examine this list with respect to 'Life Expectancy'. The reality is that you should only expect to uncover 1 or 2 ideal opportunities over a period of several years. But when you do, it pays to have the confidence to act swiftly lest you suffer the regret of not buying and holding CBA shares all over again.
What's more, this benchmark doesn't take into consideration any franking credits (tax credits) that we may also be entitled to. Be aware that whatever benchmark we choose to employ is only our starting point and should reflect our tolerance towards minimum income. As explained in an earlier article, using the example of CBA shares bought in late 1991 for $6.50, our assets will gradually mature over time. The income streams from these assets will grow in magnitude and proportionality with respect to the prices we originally paid for them. For example, if you paid $6.50 for CBA shares in 1991 then the annual dividend of approximately $2.50 per share represents an annual income stream of 38% with respect to your original purchase price whilst it only equates to a dividend yield of approximately 4.5% with respect to the current price of CBA shares. So if we were to apply a minimum benchmark of let's say 4.75% to the dividend yield of Blackmores, we can see that it would exceed our expectations in terms of income requirements.
The dilemma we now face is 'Do we buy today or, given that the share price is currently falling, do we wait for a possibly higher income yield in the future?'. The answer is…we buy if the current dividend yield is above our threshold and we continue to accumulate shares into the future if the share price continues to fall. Whereas traders will cry foul because we're averaging down our purchase price, a no-no when trading, we are in fact averaging up the dividend yield.
It is also interesting to note that when we are accumulating shares in a particular company, while the share price continues to fall, we could in fact be losing money. In other words if we add the dividend payments to our capital losses, the result is a negative one. But given our timeframe of a 'Lifetime', these losses are just the short term impact of an imperfect market entry. Fund managers will often use similar reasoning as an excuse for losses but it is only a valid excuse if their timeframe is the same as ours and they are accumulating income streams.
On a final note on income, it is always wise to ensure that the 'Dividend per share' or DPS is not of an abnormal nature and is in keeping with the normal dividend payment pattern of the company. In other words, check that the company has not paid out an extraordinarily large dividend because it's income has been abnormally inflated due to a unique circumstance such as the selling of a major asset. An example of this is when Mayne Nickless sold its interest in Optus many years ago which led to a bonus payment to shareholders of an extra $1 per share.
Assets
This section covers two very important areas…the first being the issue of 'Quality' and the second being 'Value for money'. Of course by quality I am referring to the quality of the company that the shares represent where an assessment can be made using fundamental analysis. To this end we could, once again, enlist the help of StockDoctor by only considering Star Stocks (Companies deemed to be of low risk and good future prospects by StockDoctor) as possible asset class shares. Attempting to individually assess the financial wellbeing, or quality, of approximately 500 companies is totally unrealistic and totally unnecessary given the availability of a program like StockDoctor by Lincoln Indicators. But, no matter how good the quality of any product is, I always like to pay as little as possible for it. In order to know that I'm getting a bargain, or at least value for money when buying shares, I must ensure that the P/E and P/A ratios are within acceptable benchmarks. But before we explore the question of acceptable benchmarks we should first clarify what these ratios are. 'P/E Ratio' is an abbreviation for ‘Price/earnings ratio’ and defines the relationship between a company’s market capitalization and its annual net earnings after tax. A low P/E ratio indicates that the earnings of a company are proportionally high with respect to its share price whereas the opposite is true for a high P/E ratio. Whenever the share price of a company changes or a new financial report is issued by the company, the P/E ratio will change.- Example
- A company has a total market capitalization of $10 Million.
- Its annual net earnings after tax are $1 Million.
- Therefore it has a P/E ratio of 10 ($10 Million / $1 Million)
- Example
- A company has a total market capitalization of $10 Million.
- Its total net tangible assets (ie. property, plant and equipment, etc) are $2.5 Million
- Therefore it has a P/A ratio of 4 ($10 Million / $2.5 Million)
Short Listing
The following is a summary of the minimum benchmarks that we have developed for our asset class shares. (This list excludes any discretionary guidelines such as life expectancy)- Market capitalization of at least 100 Million dollars
- Dividend yield greater than the official RBA cash interest rate (5.5% at time of writing)
- Fundamentally sound - companies must currently be StockDoctor Star Stocks
- (note: we now use our own proprietary benchmarks instead of Star Stocks)
- The P/E ratio must be less than 15 and the P/A ratio must be less than 5
| Asset Class Shares | ||||
| Company Name | Code | P/A Ratio | P/E Ratio | Dividend yield % |
| AlintaGas | ALN | 2.52 | 12.78 | 5.98 |
| AV Jennings Homes | AVJ | 1.24 | 6.90 | 10.11 |
| Blackmores Laboratories | BKL | 4.92 | 13.39 | 6.70 |
| Bristile | BRS | 2.28 | 10.57 | 5.73 |
| Casinos Austria Int. | CAI | 2.79 | 6.67 | 6.00 |
| Centennial Coal Company | CEY | 1.39 | 9.58 | 9.89 |
| Joe White Maltings | WJM | 1.45 | 8.00 | 8.58 |
| Simsmetal | SMS | 2.60 | 14.14 | 5.78 |
| Stockland Trust Group | SGP | 1.36 | 14.38 | 6.70 |