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CHAPTER 14: THE MILLION DOLLAR QUESTION: HOW MUCH TO PAY FOR IT?

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Dividend Yield Approach
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CHAPTER 14: THE MILLION DOLLAR QUESTION: HOW MUCH TO PAY FOR IT?

Dividend Yield Approach

We are not talking about the more complicated Dividend Discount Model or Gordon Growth Model here, but a simplified version. Let’s take Telekom Malaysia Bhd (“TM”) as an example.

 Table 5: TM’s dividend history (in RM sen) 2010 2011 2012 2013 2014 2015 2016 Interim 9.75 9.80 9.80 9.80 9.50 9.30 9.30 Final 9.83 9.80 12.20 16.30 13.40 12.10 12.20 Total 19.58 19.60 22.00 26.10 22.90 21.40 21.50 Capital distribution 29.00 30.00 – – – – –

I remember there was a time when I was asked to give a target price of TM using the Dividend Discount Model, which was very commonly used in the market. Back then in 2010 I chose a simpler approach.

My view was based on TM’s cash flow: TM would be able to declare at least RM0.20 worth of dividend per annum. And the target price is simply dependant on the yield required by the investors.

For example, if the investor required a 5% yield to justify investing in TM, this means that the investor will not pay more than RM4.00 for TM. How do we derive this RM4.00?

 Dividend Yield = Dividend per share ÷ Share Price

Share Price

= Dividend per share ÷ Dividend yield

= RM0.20 ÷ 5%

= RM4.00

This means that if an investor pays more than RM4.00 for TM, the dividend yield will be less than 5%.

If another investor requires only 3.0% yield, then the price that the investor would be willing to pay would not be more than:

Share Price

= RM0.20 ÷ 3.0%

= RM6.70

This is the reason why we stressed that valuation is subjective and differs between individuals. In this case, investors who want a 5% would value TM at RM4.00, whereas an investor who wants a 3% yield would value TM at RM6.70.

What makes this simple concept more interesting is if one were to look at TM’s share price chart (see Figure 1, post 2010, TM’s price range has been trading at 5% (RM4.00) to 3% (RM6.70) range.

The subsequent dividend declared by TM post 2010 did sustain around the RM0.20 levels. Some may ask: why was capital distribution not taken into consideration? The reason is that capital distribution is usually paid by paying off excess cash in the balance sheet, and it would not be a recurrent element.

This is also one type of margin of safety when investing. Rather than doing a projection of future dividend trend, use a sustainable dividend level that a company is able to pay. Any additional dividend (like TM’s case in 2013) and capital distribution will be treated as a bonus for investors.

Caution though, the dividend yield approach can only be used on companies that are able to and have been paying dividends sustainably.

Next week, we will look at the third valuation method, which is Sum-of-Parts.