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In the last edition, I wrote about dividends as income and, even if you’re not in retirement, you can use that income to buy more shares.
I touched on some stocks and what to look for and this week I want to look at the other great dividend payers: property and preference shares.
Preference shares are debt instruments issued by banks and other large JSE-listed companies.
They pay dividends based on the current prime rate and you can get some great yields with the exchange-traded fund (ETF) PREFTX, which currently offers a yield of nearly 9% – many individual preference shares offer even higher yields.
However, there are three concerns.
Firstly, you get no capital growth; you might, but that is not the design of these shares. So all you get is the same income going forward, subject to moves in the prime interest rate, and at some point in the future inflation would have eaten it all up.
The second issue is that link to prime; your upside is capped because, at the end of the day, how high can prime really go?
The prime rate is likely to move between maybe 9% and 15%. Compare this with the yield of a company that can, in theory, rise indefinitely as profits increase. So, when you own a company, not only does your capital grow, but your income grows as well.
The third issue is my concern around the downgrading of our sovereign debt to junk status.
If this happens our banks will also get downgraded and, while there is no chance of a default from our big banks, how will the market respond? I don’t know, but looking back at what happened in 2008 during the dark days of the crisis, preference shares were sold off aggressively.
Now sure, you’ll still get the income but your capital is getting killed and will it recover?
Post-2008 we’ve seen the recovery, but there’s an extra issue lurking. Due to the introduction of the new Basel III rules, banks will be getting rid of their preference shares (some have started, others will follow in time).
If prices collapse, the banks may use this weakness to quickly buy back their preference shares, locking in that capital collapse for investors.
The other option for income is property, and this is a great option. Not only can you get some attractive yields, but you also get a solid unpin of net asset value (NAV) as property stocks hold physical properties as their assets.
The issue here is the premium paid for NAV, and that has been stretched in recent years by the share prices of listed property running very hard.
You also need to hunt for the high-quality property stocks and they tend to have lower yields. A +10% yield on a property stock is overly high and carries risk. I would also have a close look at how much debt the property stock has; anything above 50% debt-to-NAV is a concern.
So what’s the answer when it comes to looking for income from investments?
For me it is about bulletproof (as bulletproof as possible) stocks such as Vodacom and Metrofile*, combined with some great property stocks, or even a property ETF.
The income starts small but grows steadily and after a couple of years makes for serious regular cash flow into my account that I can invest wherever I feel is best.
*The writer owns shares in Metrofile.
This article originally appeared in the 7 April 2016 edition of finweek. Buy and download the magazine here.
