It’s that time again.
Investors are asking whether they should buy beaten down Telstra Corporation Ltd [ASX:TLS] stock.
You can now pick up the famous dividend stock for around $2.76 per share.
I’m sure many will jump in at this price. Trading at 8-times earnings with more than an 8% dividend yield, what’s not to like?
Well, earnings and dividends could fall even lower in the years ahead. If we look at Telstra’s track record, the picture isn’t exactly rosy.
Had you bought Telstra at their all-time low in 2011, you’d have less than 8% to show for it. Adding in dividends, you’re total returns over that time would come to 65%.
Over seven years that’s an average annual return of 7.4%. And that’s assuming you were able to pick the bottom.
Even with healthy dividend payments, hindsight says Telstra was clearly not worth it. But I doubt that will stop investors from jumping in.
Now vs later
Telstra’s fall came as most falls do. The company is seeing earnings erode.
Telstra said earnings for FY18 would be at the bottom of their $10.1–10.6 billion range. ‘…price competition and the ongoing negative nbn impact on underlying earnings’ could continue to hurt earnings in the foreseeable future.
According to The Sydney Morning Herald, even the current guidance is inflated. ‘If one strips out that injection from the NBN, it appears core second half 2018 Telstra EBITDA could be down as much as $900 million.’
Ian Martin from New Street Research said: ‘there’s certainly more pain in FY2019’.
‘I also don’t think we are going to see much in terms of impact of cost-cutting on the financial results this year or next year. It’s really about repositioning the business for the post-NBN world.’
It’s why most investors still see Telstra as strictly an income stock. It’s much of the same story for Australia’s biggest banks.
From the latest figures, the big four continue to take measures to meet regulatory requirements. Meaning they’re holding more cash, which reduces overall returns.
And because earnings aren’t growing significantly, bank shares have languished.
This is a common theme for stocks on the ASX. We have income hungry investors down under. They want reliable steady payments, and it doesn’t matter if they need to buy subpar businesses to get it.
While investors should invest according to their own goals, a love of dividends has created a terrible incentive for managers.
If a company pays out sizable dividends and keeps them coming, a lot of investors will flock to the stock. But as soon as something happens to those dividends, shares fall significantly.
The message shareholders are sending to managers is: pay me now, not later.
While it’s appropriate for many businesses to pay out large dividend parcels, for others it’s ridiculous.
If you can earn a 15–20% return on reinvested earnings, why would you pay out dividends? Shareholders don’t have multiple options paying a 15–20% return (unless they find another high returning business).
Chief investment officer at Stanford Brown, Ashley Owen, wrote mid-last year:
‘Australians have always been obsessed with dividends but I would much rather invest in a company that retains its capital instead of paying it out in dividends — if it can earn a higher rate of return on its capital than I can earn if it gave the money back to me. Over the years, my best returns from shares have been in companies that never pay dividends.
‘Amazon shareholders let its founder Jeff Bezos keep the money in Amazon and re-invest it to expand the business, just as Berkshire shareholders let Buffett and Munger keep the money to re-invest it and expand. Rather than declare profits and pay tax, Amazon chooses to spend the surplus cash to expand. That’s how it grew to be the largest retailer on the planet. It has never had to raise equity since the initial $300 million raised in the 1997 float. Likewise, the vast bulk of Berkshire’s ‘profits’ are unrealised gains on their investments. They rarely sell anything and they have financed it all internally by not paying dividends.’
Take a look at how Amazon’s share price has continued to rise regardless of wider global events.
As I mentioned, reinvesting earnings is not for every business. If internal returns are low, say 5%, then it might be a good idea to pay dividends or repurchase shares (if those shares are undervalued).
But why not try to look for the next Amazon once in a while? Surely we all want to find businesses we can just buy and forget about as the stock rises higher each year?
Finding explosive gems on the ASX
Investors are not dumb. They know a good company when they see it.
It’s why companies like Amazon, Alibaba and Google are some of the largest in the world. They earn massive returns on reinvested earnings and investors are willing to pay up.
This isn’t the hard part when it comes to investing. The hard part is deciding at what price you should buy the great company.
So what can you do if all the great companies are trading on sky high valuations?
Look for companies that are on the road to success. Companies that investors are still unsure of, but could have an extremely bright future, sometimes trade for cents on the dollar.
These are exactly the kind of companies I try to find for my Wealth Eruption subscribers. In this brand new service, I’ve already recommended six ASX stocks with huge upside exposure to Asia.
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