The fear of having not enough money or losing our job makes one think about how to create multiple streams of income. It has been a popular topic since many years ago in this uncertain world we live in. Just these few months, I’ve heard a few people got retrenched. This makes me wonder when will I be next?
However, when we are already so busy with our work, how do we even have more time to create more streams of income? Its quite impossible to take up another part time job or even do freelancing when time is so tight for everyone. So, how can we create more streams of income using the least amount of time and is this realistic? Let’s take a look at how it can be done.
Dividends from Stocks as an Income Source
If you’re thinking of whether dividends from stocks can possibly be a source of income, the answer is yes. There are real life examples of people who manage to create $10k or even $100k of dividends through stocks. A few of my financial blogger friends have already achieved that.
However, nothing comes easy. Through my conversations with some of these friends who have already done that, let me share what did I find out.
1) Save Save Save
The first step to creating dividends from stocks is to save up. Without any investment capital, there is no way we can get dividends. Maybe you think you can invest $1000 and get $10,000 easily. The reality is not the case.
2) Look out for opportunities when its gloomy
Many people make their first pot of gold when a crash happens. This greatly increases our investment capital which will be useful for dividend investing.
Many multi baggers are made during a market crash. This means we could make more than 100% return on our investment on a single stock. This kind of opportunity doesn’t come all the time so take advantage of it when you see it. How to know which stock to buy? This brings me to the next point.
3) Learn how to value companies
Buying stocks at the right price is all about knowing how to value a company. How much is the company really worth?
There are many variations on how valuation can be done If you read it up on your own, most probably most beginners will get confused. The most basic form of valuation is the PE ratio. There is no one fixed number we should look at. A PE of 20 for one company compared to another company with PE of 10 doesn’t mean much if we do not understand what is it about. The PE ratio is calculated by taking the Price (Stock Price) divided by the Earnings (Earnings per share) of the company. If the Earnings of the company drop sharply and price remains the same, PE ratio will be a very high number. Similarly, if stock price goes up a lot while earnings remain the same, the PE will be very high. As such, a low PE is generally better than a high PE.
One way to look at PE is to compare the PE of companies in the same industry. The company with lower PE is more attractively priced than another company with higher PE. Let’s take for example 3 companies in the Telecommunication industry namely Singtel, M1 and Starhub. Here’s their PE:
Singtel PE: 16.46
Starhub PE: 14.39
M1 PE: 13.12
If we just base on PE from the above, M1 seems to be most attractively priced. Does it mean we buy M1 straight away? The answer is no. Previously I wrote an article about how Starhub went wrong as an investment. It is a lesson that if we buy at the wrong price, the whole investment can suffer.
Valuation has a second part where we try to project the future PE. We have to ask ourselves if we buy M1 at current PE ratio, is it really attractive? The PE ratio is low now base on current price and earnings. If earnings of M1 drop further, the PE will shoot up again. Most of the time, the stock price will also drop to reflect a fairer PE ratio. Earning drop and price drop will re-balance back the PE.
Another scenario is where the PE is not that low now but we predict that earnings will go up. If earnings really go up, the PE will be lower thus making it more attractive. The most ideal scenario is where the PE is low now and we also predict that earnings will go up. Most of the time, the stock price will go up thereafter to reflect the valuation.
In summary, PE ratio is useful for valuing a company base on its price and earnings. A PE of 1 means the company is making a profit that is equal to its price. Let’s say a company has $100,000 worth of stocks (investors money) and it made earnings of $100,000 that same year, its PE ratio is therefore 1. PE ratio can also be described as the number of years it takes for investors to get back their money.
There are many other valuation methods such as using the price to book ratio which is a valuation of a company’s assets. Some investors use other models such as calculating the intrinsic value or looking at the cash or free cash flow. It will be confusing if we’re not finance or accounting trained but all these can be learnt if we are really determined to do so.
4) Don’t be fooled by high dividends
Getting dividends from stocks doesn’t mean we just go for the stock which has the highest dividend yield. Since we are investing into these stocks to get a second source of income, we want the income to be stable as well.
When companies pay out dividends, they have to get the money from somewhere. If a company has a payout ratio of 100%, this is unsustainable in the long run. It is likely the company will reduce its dividends later on. A company who pays out 100% of its profits in dividends do not have money to continue growing and expanding.
Another thing to look at is whether the companies’ profit will be stable? If profits are not stable, it is likely the dividends will be affected later too when earnings drop.
Other multiple streams of income
With limited time, it is honestly quite hard to create more sources of income. We can build websites, publish books, sell items, do freelance etc. But, all these take time and effort.
To me, I would think dividends from stocks is an achievable stream of income. The hard work is certainly needed at the start but as time goes by, we will get more and more familiar. We can buy a company and hold it for the long term while monitoring its financial results only once every quarter. If you realise, there are some very stable stocks which gives good dividends in Singapore. In that case, we don’t even have to monitor much.
Take the first step to invest and create a second stream of income!
New to Dividend investing? These articles will get you started: