Generating a low-risk income in the stock market has been a difficult task every investor is looking for a solution to. With share price going up, falling hard like a rock coupled with inflation rising year on year to an all-time high, the stock market looks like the least place to put one money because you could lose your capital or even exit the market with lesser cash (after incurring loss) that’s not able to meet your needs.
But the search for alternative high return also seems more complicated than it has been previously. And the simple truth is that you can’t stick your money into a mutual fund or fixed deposit and expect the best. In fact, with the headline inflation rate reaching 18.22%, a mutual fund or FGN bond-heavy portfolio is likely to underperform or even lose purchasing over time.
A simple way to understand this is to look at SBM Jollof Rice Index, a composite index that tracks how much it will cost to make a pot of jollof rice across 12 markets in seven states in the six geopolitical zones for a family.
- The average cost of making a pot of jollof rice in Nigeria increased from N7,167 recorded in Q4 2020 to N7400 in the first quarter of 2021. representing a 3.24% quarter-on-quarter increase. (source)
Personally, I think this is an estimate from a man because it doesn’t reflect today’s market reality. A woman will most like give us a more accurate percentage increase which I think should be between 20-30%.
As an investor seeking better ways to generate more cash flow that will beat the rising cost of food, here are simple steps to creatively use dividend in the stock market to beat the double-digit growth in inflation.
1. Save towards your investment.
The only way to make money, generate passive income and sustain cash inflow is to invest money, there is no magic. You need to save a reasonable capital that’s enough to buy shares of good companies. There are good savings and investment apps you can explore to achieve this.
Depending on how much you need, the basic estimate is to dividend your annual expenses by a minimum dividend yield of 10%.
The 10% is a static parameter that helps us to focus on solid stocks that offer a 10% yield at the end of their financial year.
So if your estimated annual expenses sum up to N800,000, you need a starting capital of N8,000,000 (N800,000 dividend by 0.1).
2. Go for Solid Dividend Stocks
Dividend stocks are one of the best vehicles of long-term investing in Nigeria but I often wonder why investors are not taking advantage of the opportunities. You can take leverage the zero cost of accumulating more units of your equity in a company to power your cash flow to the moon.
I know investors that use the dividend to pay their children schools, or even finance standard of living. They are less concerned about capital appreciation but keen on cash distribution which also removes the burden of tracking stock prices, picking stocks and analysing the market every day.
A portfolio of well-managed companies that have demonstrated a track record of performance, high return on equity, efficiency, good management with regulatory backing, is all you need to generate sustainable cash flow.
I ran a scan of profitable stocks that offer dividend yield above 10% with a return on shareholders equity (ROE) above 10%, guess what I discovered? Guaranty Trust Bank, Zenith Bank and UCAP – these 3 stocks, as at the time I checked them, had an ROE of 26.57%, 23.11% and 40% respectively while dividend yield prints at 10.71%, 13.04% and 11.24%.
Did you know these 3 stocks are enough to generate long-term portfolio return (above 19% year on year) that beat inflation in just 3 years if you follow the strategy I am about to share?
Let’s assume I invest an equal amount from the N8,000,000 startup capital, that’s like N2,666,600 on Zenith Bank, GTB and UCAP.
Remember, we are looking for cash distribution to pay bills and not share price appreciation and also, we’d be holding these stocks for 3 years irrespective of the market cycle or share price fluctutations before we spend the cash.
If I bought N2,666, 600 of GTB, Zenith and UCAP at the market price of N28, N23 and N6.23, that gives me 95, 235 units, 115, 939 units and 428, 025 units respectively.
What’s my cash distribution at the end of the first year?
Let’s just use the yield to see what we would likely have in our portfolio after receiving our portion of cash paid to shareholders and re-investing the money back to these individual stocks.
- GTB shares – 10.71% of N2,666, 600 would have given be N2,952, 192
- Zenith bank shares – 13.04% of N2, 666, 600 equals N3, 014, 324
- UCAP shares – 11.24% of N2, 666,600 would earn N2, 966, 325
The new value of our dividend stock would have increased from N8,000,000 to N8, 932, 841 which is like 11.66% but you know what? you may get a modest figure if you use the same model in the second year because stock prices fluctuates, so it’s best to assume that the company will continue to pay the same amount year on year.
The NSE market looks overbought on the monthly chart. Like I have said in my earlier post, correction is imminent after a 50% return in 2020. A bear market may not be the time for shareholders that are looking for appreciation but cash distribution.
Cash distribution at the end of the second year.
Because we are in a bearish market, it’s safe to assume that these stocks may drop by at least 10% in the next 12 months. So we’d be looking at GTB, Zenith and UCAP’share selling at N25.2, N20.7 and N5.6, by the time we buy more shares with the cash distribution, we would have unit holding as thus:
- GTB – The cash distribution of N285, 592 in the first year divided by N25.2 should give us 11, 333 units plus our initial unit of 95, 235, that’s 106, 568 units.
- Zenith Bank – The cash distribution of N347,724 in the first year dividend by N20.7 should give us 16,798 units plus 115, 939, that’s like 132,737 units.
- UCAP – The cash distribution of N299, 725 in the first year dividend by N5.6 should give us 53,522 units plus 428,025, we’d have 481, 547 units
Each of the companies (GTB, Zenith and UCAP) paid a dividend of N3, N3 and 70k at the end of the 2020 financial year, so we’d assume a constant dividend payout year on year.
Let’s use the data above to compute the total value of our portfolio at the end of the second year; expected dividend in the second year by multiplying the dividend per share by total units owned by each of these companies.
- GTB; 106, 568 units x N3, that should earn N319, 708 plus our portfolio value of N2,685, 513 (106, 568 units x N25.2 market price) = N3, 005, 221
- Zenith; 132, 737 units x N3 equals N398, 211 plus our portfolio value of N2, 747, 655 (132, 737 units x N20.7) = N3,145, 866
- UCAP; 481,547 units x 0.70 equals N337, 082 plus our portfolio value of N2,696, 663 (481,547 units x N5.6) = N3,033,745
The estimated value of our portfolio would be N9,184, 832, an increase of 2.8% over N8, 932, 841, the value at the end of the first year.
You’d notice that despite a 10% fall in overall share price since the market sentiment is negative, our hypothetical portfolio value outperformance growth investors seeking capital appreciation in the same period.
Cash distribution at the end of the third year.
Let’s assume that the bearish trend continues with the share price tanking by another 10%, then GTB, Zenith and UCAP should sell for N22.68, N18.63 and N5.04.
We’d able to buy the following units of these stocks with the cash distribution of year 2:
- GTB; 14, 096 units (N319, 708 divided by N22.68) which should increase our total units to 120, 664 units
- Zenith; 21, 374 units (N398211 divided by N18.63) which should also take our total units to 154, 111 units
- UCAP; 66,881 units (N337,082 divided by N5.04) to grow our units to 548,428 units
We’d then compute the total amount earned as a dividend and add back to the value of our portfolio using the recent market price.
- GTB; 120,664 units x N3 equals N361,992 plus N2,736,659 (120,664 units x N22.68) = N3,098,651
- Zenith; 154,111 units x N3 equals N462,333 plus N2, 871,087 (154,111 units x N18.63) = N3,333, 430
- UCAP; 548,428 units x 0.70 equals N383,899 plus N2,764,077 (548,428 units x N5.04) = N3,147,949
How much is our portfolio worth at the end of the third year? N9,580,030 (N3,098,651+N3,333,430+N3,147,949)
This also means that our portfolio value went up by N395, 198, which is 4.3% over N9,184, 832.
From the modest analysis, you can see how a pool of solid dividend stocks with an aggressive re-investment strategy can grow a portfolio by 19.7% in 3 years despite a 19-20% drop in share price or total market capital in a similar period.
Guess what? This is the strategy professional equity portfolio managers use to grow their client’s wealth that you don’t know. Before I discovered this secret I’d always ask why these investment managers are still in business when the overall market keeps going down until I found the power of dividend reinvestment and compound return from small cash distributions.
3. Commit and Reinvest your Earnings
I just demonstrated the advantage of not spending your cash dividend in the first year and how it can power your portfolio in a bear market. When you re-invest your earnings for the first three years, you buy more shares at zero cost when tends to increase your next dividend payment for more than your previous payouts. This is the zero-cost way to generate more cash flow that will pay your bills.
If you decide to continue the re-investment strategy for your kids, I am sure you wouldn’t even bother about their school fees or education till they graduate. No exaggeration, that’s the unknown truth that’s hidden in the stock market.
The information I shared is based on assumption that the company will pay the same amount as dividend which isn’t totally correct, over time these companies have paid the increasing amount but economic uncertainties may affect the payout.
I also assumed that the share price may dip because the market sentiment already points to possible sell-offs in the next 2-3 years following the significant share price rally last year (2020).
All these may affect the estimated value of our portfolio and as such should make you do your due diligence before adopting the dividend re-investment approach.