Q&A with CMMB Securities

Q. I want to invest in the stock market, but my wife says we should reduce our debts first. I think the profits we make from our investments will pay off some of those debts. What’s your view?

Brent, Couva

A: The answer to this question is premised on three factors:
(i) The interest or cost of your debt,
(ii) The expected return from investing in the stock market and
(iii) The amount of risk you can undertake given that you have a fixed debt obligation. Currently interest rates are at an all time low, so if you have secured debt at a low cost your expected return on the stock market is likely to exceed your cost of debt. This being the case, you can invest in the stock market or a mutual fund and increase your wealth by the excess of your stock market returns over your cost of debt. The local stock market continues its upward trend and from January to the present, the Trinidad and Tobago Stock Exchange Composite Index posted gains of over 21 percent. We expect this upward trend in the market to continue for the rest of 2004, though at a much slower pace and with some correction taking place in the second and third quarters as the earnings season unfolds.

Stock market investing entails sizeable risk. Therefore, you have to determine whether you can continue to pay your debts in the event of losses in the stock market. One final factor to be concerned about is the lack of liquidity on our local stock market, which will affect your ability to buy shares when you want and also your ability to sell shares when your debt payments are due. One alternative to this problem is to buy into a mutual fund of which at least 60 percent is invested in equities, but is more liquid.

Q. What are dividends and why do some companies have them while others don’t?

Carolyn, La Romain

A: A dividend is a payment to the stockholders of a company, using profits from the company as declared by the Company’s Board of Directors. Dividends may be in the form of cash or stock. A dividend is one component of return of a stock and is intended to partially reward the investor for holding that particular stock. The other component of return or reward is the capital appreciation or price increase of the stock. Any company that has historically maintained an impressive pay-out ratio (the portion of profits which is paid out as dividends) can be termed an income stock. An impressive dividend yield (which is simply the dividend per share divided by the current price) is not necessarily good for an equity investor.

This is because a high dividend yield may come at the expense of low price appreciation, the other component of return for investing in stocks. The logic is that a company which usually pays a high dividend would not grow as much as a company which pays a low dividend. Earnings represent the residual income after all the company’s obligations are met. These earnings are available to shareholders. If the company decides to pay all of its earnings as dividends then there is none left to reinvest in capital projects that will expand the company. Management will normally decide how much money is needed for investments in the future, which will determine the growth of the company.

As the company grows, so does its share price, allowing investors to get returns from the increased price of the stock. However, if Management believes there are no worthwhile capital investments to be made in the near future, they would then decide to pay more dividends, leaving it up to individual shareholders to invest their money. These individual investors may be able to earn a higher return from investing elsewhere.

Disclaimer for Articles:

“All information contained in this article has been obtained from sources that CMMB believes to be accurate and reliable. All opinions and estimates constitute the Author’s judgement as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by CMMB in any form whatsoever. CMMB and/or its employees or directors may, where applicable, make markets and effect transactions, or have positions in securities or companies mentioned herein. Neither the information nor any opinion expressed, shall be construed to be, or constitute an offer or a solicitation to buy or sell.”