Where is the Ceiling for High Dividend Strategies?

The high dividend strategy investment is essentially a medium to long-term investment and value investment, focusing on dividends for many years to come, and not overly concerned with short-term fluctuations in secondary market stock prices. Therefore, its difficulty lies in predicting the future profitability of companies.

In the past two years, stocks with higher dividend yields have significantly outperformed the A-share index. When will they reach their peak? Where is the ceiling for the high dividend strategy?

The author believes that it depends on the specific circumstances of different industries and individual stocks, as well as the nature of the buying funds.

Different industry categories:

Firstly, for stocks with expected declines and future dividends that will decrease, a dividend yield of 7%-8% may not be appropriate, and the stock price may not necessarily strengthen. This is because their dividends may be high this year but could be low next year, lacking sustainability, and one should not simply base long-term investments on high dividends.

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The most typical case is a leading real estate company. Its dividends used to be quite good, with per-share dividends of 1.045 yuan, 1.017 yuan, 1.25 yuan, 0.976 yuan, and 0.68 yuan for the years 2018-2022, respectively. However, in 2023, the dividend was zero. Due to the typical cyclical nature of domestic real estate development in previous years, where rising housing prices affected land prices and residential sales volumes, leading to significant performance fluctuations, if one bought this stock around 2022 because of a high dividend yield of 5%, the investment would suffer heavy losses. Its stock price once reached as high as 19 yuan in 2022, and now it is only around 8 yuan.

Secondly, for stocks with a good competitive position in their industry, stable net profit expectations, low corporate debt ratios, good operating cash flows, and secure future prospects, the author believes that a dividend yield of 3%-5% is currently acceptable. However, in three to five years, due to further interest rate declines, it is estimated that the market will scramble for such stocks until the dividend yield drops to around 2%-3%.

An example in this regard is China Yangtze Power. The Three Gorges Group behind China Yangtze Power has essentially included all its main hydropower stations in the listed company. The base of hydropower installation is too large, making it difficult to achieve high growth in the future, but the advantage is stable returns, almost a natural monopoly. Its dividends for 2021 to 2023 were 0.815 yuan, 0.853 yuan, and 0.82 yuan per share, respectively, showing little growth. However, since the end of 2022, its stock price has risen by about 40%, mainly because in the context of domestic interest rate cuts and a significant decline in market interest rates, the expectations or tolerance for China Yangtze Power's dividend yield from institutions at that time, which was over 4%, has now become around 3%.

Lastly, for stocks with stable growth expectations, good market prospects, strong competitiveness, and a moderate amount of capital expenditure and new business projects, if the expected net profit growth is around 5%-10% per year, then a current dividend yield of 2%-3% is also quite good.

Such stocks can be represented by Tencent Holdings in the Hong Kong stock market. The dividend tax in the Hong Kong stock market is high, and its post-tax dividend yield is also around 2.5%. Despite its large size, Tencent's WeChat product has a monopolistic position and is the number one internet entry point in China, and its performance growth expectations for the next few years should not be too bad.Of course, if it's a small-cap stock or a growth stock, due to the high capital demand and significant capital expenditures of the company, dividends are naturally low, and there's no need to focus on dividend yield for investment; that's a completely different strategy.

High dividend strategy investment is essentially a medium to long-term investment, value investment, focusing on dividends for many years to come, and not too concerned with short-term secondary market stock price fluctuations. Therefore, its difficulty lies in predicting the company's future profits. Some industries are relatively easy to predict performance. For example, hydropower, water supply, highways, essential consumer goods, basic telecommunications, coal-electricity cogeneration, etc., their performance is relatively stable, so they become the favorite investment targets of high dividend strategies. On the other hand, thermal power, coal, nonferrous metals, petrochemicals, gas supply, etc., are greatly affected by the fluctuations of commodity prices, and their performance is relatively unstable, and dividends each year will also be unstable.

Bank stocks are an exception:

Bank stocks seem to be categorized as cyclical industries, but banks have many means to adjust profits, and annual dividends are relatively stable. Their overall dividend yield is currently high and quite common. However, among high dividend strategy investors, there is a significant divergence in expectations for the future performance of bank stocks, which prevents them from continuously rising in stock price like Yangtze Power and compressing the dividend yield to around 3%. Affected by the narrowing interest spread due to interest rate cuts, some banks experienced negative profit growth in 2023, and there may be more banks with negative profit growth in 2024, with relatively pessimistic expectations for future performance growth.

However, despite the potential for reduced performance and decline in the future, the annual dividends of banks do not necessarily have to decrease. This is because the current domestic loan demand is not strong, and the future loan growth rate may decrease year by year (which is also one of the reasons why performance is hard to grow), banks' risk asset growth is less, which will lead to less capital consumption, and a more stable capital adequacy ratio, so their annual dividend payout ratio can be continuously increased, currently only generally within 30%. Theoretically speaking, if bank loans do not grow, the annual net profit dividend payout ratio can be increased to 100%.

Assuming a pessimistic scenario where bank performance decreases by 30% over the next five years, and the dividend payout ratio is increased to 60%, then the annual dividends of bank stocks can increase by 40%. If investors' expectations for dividend yield remain unchanged, then bank stock prices could rise by 60%-70% over these five years (i.e., 40% + an annual dividend yield of 4% to 6%). One of the reasons is that the current domestic bank stock PB is too low, generally only 0.4-0.8 times, as long as the future annual return on equity (ROE) can be 5%-10%, then the long-term dividend yield will not be bad. In this sense, if the country can hold the bottom line of not having systemic financial risks, can improve supervision and management year by year to improve credit quality, and digest the historical burden of real estate and urban investment, then after the interest spread stabilizes, bank stocks have every hope of becoming the "Nifty Fifty" or "Seven Sisters" that drive a new round of bull market. Against the backdrop of little change in net profit, the valuation can change from the current P/E ratio of 4-6 times to 6-12 times, and the adjusted stock price can double.

Capital preference:

The market currently generally predicts that China's deposit and loan interest rates may still be reduced in the second half of the year, and the United States may cut interest rates around the end of the year, so the stock prices of high dividend stocks may still have some room for increase at that time. The main reason is that insurance companies can no longer easily cover the cost of medium and long-term policies solely through high-grade bonds and interbank certificates. After all, the current interest rate of China's ten-year government bonds is around 2.3%, and it may be below 1.5%-2% in a few years. The current relatively safe high-grade bond yields are generally around 2.5%-3%, while the overall implied cost of many insurance policies may be 3%-4%. Similarly, some prudent investors and institutions such as pension funds, in order to find bond substitutes, can only increase their allocation to high dividend yield stocks. The downward trend in interest rates leads to a scarcity of fixed income product assets, mainly relying on high dividend yield stocks as a substitute.

As for public fund management companies, historically, their active stock fund products generally do not like to buy high dividend yield stocks. This is because these stocks generally have poor growth, and the expected annual returns in the future will not be too high. Without secondary market speculation, in the long run, they are only slightly higher than their dividend yields, for example, only 4%-8%. After deducting the 1%-1.2% (previously 1.5%) management fee of public funds, there is only 3%-6.8% left, which is hard to convince people to buy. Historically, Chinese stock investors have high expectations for stock returns, thinking that if they don't make more than 20%-30% in half a year or a year, why enter the stock market? If you have such thoughts, it is not suitable to buy high dividend yield stocks. Having high expected returns in the short and medium term is obviously more suitable for investing in growth stocks.

Matching the high expected returns of retail investors, domestic active stock funds prefer to heavily invest in growth stocks and track stocks, and these stocks have not performed well in the market in the past two years because they have to rely on the hot sale of public funds. Without hot sales, there is a lack of funds to take over, and it is difficult to have a big market. In the past two years, it has been the dividend-themed public fund products that have performed well because they fit the overall trend of interest rate decline, institutions turning to defense, and reduced risk preference. However, the number of such public funds is still relatively small.After 2000, the high dividend strategy in the Japanese stock market also achieved relative returns, significantly outperforming the index. One of the reasons is the continuous decline in interest rates. The dividend yield of major dividend stocks can be stabilized at around 3%-4%, which is much higher than the yield of Japanese 10-year government bonds (around 1%). Currently, the Nikkei index is about 3-4 times the low point at the beginning of 2000. Therefore, the actual annualized return of high dividend strategy investors over these more than 20 years will be far higher than 3%-4%. Because 3%-4% is only the annual dividend income, investors can also gain from the rise in secondary market stock prices. After the stock price rises, because the dividends of listed companies increase year by year, the dividend yield can remain relatively stable. Against the backdrop of declining interest rates, it can in turn support further increases in stock prices. This is patient capital and a virtuous bull market.