EMBRACING STOCKS AND THEIR DIVIDENDS

Alittle well-placed knowledge might result in long-term steady riches. At parties and informal gatherings do you often find yourself nodding at what your financially savvy friends say, but then stay silent and hope no one asks you a question you can’t answer?

How often does that happen when they’re talking about their stock portfolios? If that resonates with you, take comfort in knowing that you aren’t alone!

Most of us start off our adulthood not knowing much about finance and economics; also, the arcane subject of equity investments is often a source of confusion. Thankfully though, learning the basics of intelligent direct stock investing is not difficult.

Don’t get me wrong: Transforming into the next Warren Buffett, Peter Lynch or Sir John Templeton is unlikely. But it’s possible for you to gain a practical working knowledge of stock investing that will hold you in good stead in the decades ahead.

To help set you on this potentially profitable path, let me tell you about six quantifiable investment metrics: Imagine a small private business on a street near your home. What is it worth? Chances are its value is more a guess than a coldhard fact. For instance, if it’s a small bicycle shop, it may be worth between RM50,000 and RM75,000. In reality though, you won’t be able to pin down a value until a bona fide offer is made to buy it outright.

If the business in question, however, were a hypothetical Malaysian bank listed on Bursa Malaysia, which we’ll call Honest Bank Bhd, you can figure out what its market-determined value is by multiplying its current share price, say RM10, by the number of its issued common shares, say, five billion.

Share price x number of shares = market capitalisation or market cap.

In this case the market cap = price per share x number of shares = RM50 billion.

Its market cap is the value the stock market places on Honest Bank in its entirety.

To figure out if Honest Bank is doing well or not, its net profit should be calculated. That’s done by taking its revenue or turnover and subtracting its expenses, which leaves it with profit before tax.

Once Honest Bank’s corporate taxes are paid, what’s left is its profit after tax. From that quantity, something called minority interests is subtracted.

Profit after tax and minority interests (MI) = net profit.

If you owned all of the bank and if it earned, say, RM2 billion in net profit last year, you can see that its current market cap (RM50 billion) divided by its latest net profit (RM2 billion) = 25 times.

You call 25 the earnings multiple because you’d have to hold the bank for 25 years — assuming steady annual profits — to earn back its full current value.

A bank listed on Bursa Malaysia has lots of partial owners. Therefore, a better way to look at the fractional ownership of Honest Bank that you might enjoy is to consider its earnings per share.

Earnings are its net profit, which is RM2 billion. We assumed earlier the bank has five billion shares outstanding. Therefore, earnings per share or EPS = RM2 billion divided by five billion shares = RM0.40 or 40 sen. It’s the share of earnings the owner of a single share of Happy Bank can lay claim to.

Earlier, we stated the share price as being RM10. The PE ratio = price-earnings ratio = price per share divided by earnings per share.

So PE = RM10 divided by RM0.40 = 25 times, which is the earnings multiple!

DPS stands for dividend per share. If Honest Bank pays out 8 sen a share each year in dividends, then its DPS = 8 sen.

Finally, dividend cover tells you the number of times a company can meet or ‘cover’ its annual dividend.

Specifically, dividend cover = EPS divided by DPS. In our case, that comes to 40 sen divided by 8 sen, or five times cover or 500 per cent cover. A situation like this is excellent because the company retains plenty of excess earning capacity to cover its crucial annual dividend. This suggests that in the years ahead our hypothetical bank will be able to bump up its annual dividend at a nice, healthy clip while still retaining lots of undistributed net earnings to reinvest back into the business.

I suggest you reread this column, with pen and notebook in hand, to remind yourself of these vital investment metrics. Internalising these lessons may change your life.

After doing so, engage your more financially-literate friends in conversations about their steady dividend-paying stocks. Use the correct terms to wow your friends and to gain useful investment information you may harness to create a growing river of passive income drawn from a diversified portfolio of selected stocks.