This article first appeared in The Edge Financial Daily on September 3, 2019

KUALA LUMPUR: There are expectations of another 25-basis-point cut in interest rates by year end as the global economic outlook becomes gloomier as a result of rising trade tensions between China and the US.

Already, Malayan Banking Bhd and CIMB Bank Bhd are expecting Bank Negara Malaysia (BNM) to cut the overnight policy rate (OPR) further by end-2019.

In such a low interest rate environment — likely to prolong as this is useful for governments worldwide to stimulate their economies — companies with resilient earnings and regular dividend payments tend to be appealing because the difference between a dividend yield and a bank’s interest rate will be wider, according to fund managers when contacted by The Edge Financial Daily. Nonetheless, they stressed that a dividend yield is not the only yardstick to select stocks.

In May, BNM was one of the central banks that took an early pre-emptive move to cut the OPR to 3%.

Fundsupermart Research analyst Jerry Lee Chee Yeong said recession fears are brewing, prompting central banks worldwide to trim rates further, keeping them low.

“Earlier this month, the inversion of the US 10-year and two-year Treasury yield curves prompted investors to look into those fixed income assets especially the safer class government bond.

“If the central bank cuts rates further, there will be a downward pressure on Malaysian Government Securities (MGS) yields,” said Lee.

At the time of writing, BNM data showed the 10-year MGS yield closing at 3.12%, spiralling downwards since its 2018 peak of above 4.2% in May (the 14th general election month), according to Bloomberg data.

Historical yields not quite a good yardstick

Historical dividend yields reflect companies’ generosity in paying dividends. However, the fund managers stressed that companies’ resilient earnings that generate healthy cash flow are crucial to allowing them to consistently pay dividends.

Phillip Capital Management Sdn Bhd chief investment officer Ang Kok Heng cautioned that dividend payouts are historical, hence it is more important to find out whether such payouts are sustainable going forward.

“If dividend [payouts] drop because of weaker earnings, then the share price will follow suit. When share prices come down, then you will also lose that capital,” said Ang.

For instance, he explained that if one were to earn 6% in dividend but loses 10% in share capital, the investor would still be losing out. Thus, he highlighted investments in dividend stocks are not risk-free.

Ang also said having s sustainable recurring cash flow is important to measure a counter’s ability to continue paying dividends.

He pointed out that ideally, good dividend stocks are companies with resilient earnings even in a harsh economic environment and that they are willing to declare dividends.

“If the market comes down because of an economic slowdown or a trade war, it may affect the businesses of some of these high-dividend yield stocks,” he said.

Fortress Capital Asset Management (M) Sdn Bhd investment adviser and director Geoffrey Ng concurred, saying investors should also monitor companies with high free cash flows, or those that do not need much capital investment for growth.

“A high payout ratio does not necessarily mean a high dividend yield since payout ratios are a percentage of net income — an accounting number and not necessarily all in cash.

“Some companies fund dividends from debts which, again, is not necessarily healthy or sustainable,” said Ng.

Ng also said it is important to monitor whether a company has controlling shareholders, for example, a multinational corporation, which requires flowing up dividend income as part of its operational policy.

Another group of dividend stocks to look into is government-linked companies given the government’s current tight fiscal position, no thanks to high national debts inherited from the previous Barisan Nasional government.

Having said that, some dividend stocks are already sought after.

Areca Capital Sdn Bhd chief executive officer Danny Wong Teck Meng highlighted dividend stocks are already running ahead, as investors had more or less anticipated another rate cut.

“The problem now with dividend stocks is not all of them are performing well in earnings,” Wong said, adding that these dividend stocks’ ability to continue paying good dividends remains in question.

“If a company’s earnings are growing ... in general, we would assume its cash flow is enough, unless you’re doing exceptional things.

“But if its earnings fall, then the worry is whether the same portion of cash from the earnings will also come down or if it could drop faster than earnings.”

Wong added that studying a company’s shareholding structure is important. “If the [controlling] shareholders need money, then the counter will pay dividends, even if they may not have enough earnings to pay, but they can pay out from their retained earnings.”