We know that investing in high-growth companies can be very rewarding. But there are more ways to make money than investing in growing companies.
A classic example
A great example of a company that has not grown but has still given shareholders sizeable returns is Vicom Limited (SGX: WJP).
Vicom is a vehicle inspection company based in Singapore. It is mandated by Singapore laws that all cars in the country have to undergo an inspection either annually or once every few years depending on the age of the car. A majority of the vehicle inspection centres in Singapore are run by Vicom, giving the company close to a 75% market share in the sector.
However, because of its relatively high market share, Vicom has limited opportunities to grow. Moreover, in recent years, the Singapore government has targeted zero vehicle growth on the roads to reduce congestion. This has limited the expansion in the addressable market for vehicle inspection in Singapore.
I also suspect that Vicom’s inspection business is regulated by the government, which limits the company’s ability to increase its prices too aggressively.
Because of these reasons, Vicom’s business has been stable but growth has been non-existent. The table below shows Vicom’s revenue and profit since 2012.
The company’s revenue and profit have barely budged for a decade. Yet shareholders who bought Vicom’s shares in 2012 have made a healthy profit.
A decade ago, the company’s share price was S$1.13. Today, they are norht of S$2. As such, Vicom’s shareholders have enjoyed capital appreciation of 82%. In addition, shareholders have collected a total of S$0.751 per share in dividends, which translates to a 66% yield based on the S$1.13 share price.
What’s the catch?
Shareholders who held on to Vicom’s shares for the past 10 years had earned a total return of 148%. And that’s even excluding any potential returns from reinvested dividends.
So why were shareholders so well-compensated despite Vicom not growing in the past decade?
Firstly, Vicom’s shares were trading at a low price a decade ago. At that price, investors could scoop up shares relatively cheaply and earn a decent return simply by collecting dividends.
Secondly, Vicom’s management decided to reward shareholders by paying a much higher dividend per share over time. Vicom had accumulated large amounts of cash on its balance sheet over the years and had little use for it. You can see this play out over the years as Vicom’s dividend payout ratio rose and exceeded 100% in four of the last five years. Management’s decision to pay shareholders a larger dividend caused Vicom’s share price to appreciate as investors were willing to pay a higher price given the higher dividends.
From this, we can see that when investing in no-growth companies, shareholders need to buy at a low valuation and hope for a rerating in the share price to make a capital gain. Oftentimes, a catalyst needs to occur for the share price to appreciate. In Vicom’s case, an important catalyst was management’s change in stance toward its dividend payout ratio.
If you buy Vicom’s shares today, it is unlikely that its share price will appreciate at the rate it did in the past, given the already high valuation of the shares today and the limited opportunity for further dividend growth given the already-high payout ratio.
What to look out for when investing in no-growth companies
Investing in companies that are not growing can still be rewarding. But it is important to know that not all no-growth companies will perform as Vicom did.
When looking at slow-or-no-growth companies, one of the main things to look out for is a low share price. If a company is trading at an unreasonably low multiple, even if its earnings don’t grow, the share price can still appreciate over time.
Next, when investing in slow-or-no-growth companies, it is important to look at the company’s cash position and dividend payout ratio. A company that has more than sufficient cash on its balance sheet is likely to eventually decide to pay that excess cash out as dividends. This provides shareholders with more dividends and can be a catalyst for a re-rating of the share price.
Third, look for a business that is resilient. Vicom’s business has not grown in a decade, but its revenue has not declined either.
If you invest in a company whose profits are declining, the valuation multiple might compress further and what may seem like a value stock will end up as a value trap. On top of that, if profits are declining, management will probably not increase its dividend payout ratio in a bid to use its cash to reaccelerate growth, oftentimes ineffectively.
Lastly, because dividends are a major source of returns when investing in a slow-or-no-growth company, it is important to find companies that are domiciled in places where there is no withholding tax on dividends. For example, if you’re a Singaporean investor, you should not have to pay tax on your dividends. But if you invest in US stocks, there is a 30% tax. As such, it is best to stay away from such companies in the US.
The bottom line
There are many ways to invest in stocks. Although I prefer to pay a higher multiple to invest in growing companies, other investors may prefer to buy no-or-slow-growth companies at a low multiple and wait for valuation re-ratings and/or to collect dividends.
Whichever method you prefer, the main thing is to find a style that you are comfortable with and suits your investing appetite.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
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Disclosure: Jeremy Chia does not own shares in any of the companies mentioned.