COMMENT

A cooling market requires a new strategy

The JSE looks expensive, there’s no doubt about it. It’s been trading at or near record highs for the past few months — and the earnings aren’t necessarily there to back up the lofty levels. Current valuations show the market trading at around 19 times reported earnings, well above its historical average. That may come down slightly at the end of the current reporting season, but not by much if corporate results so far are anything to go by.

Analysts expect the market to move sideways for now, but a correction could also be in the offing. Commentators suggest a pullback of 10% or more. So, as the market cools off you’re unlikely to see much capital growth on your investment unless you are a canny stock-picker.

While one school of thought is that targeting dividends is best for those entering retirement and requiring an income, another camp believes targeting dividends regardless of age or investment stage will add to your capital growth in the long term, if those dividends are reinvested.

Do the sums: it can make a massive difference. You can double your returns over a 40-year period just by reinvesting a couple of percent a year. The trouble is earnings — and dividends — can be erratic, which is why some fund managers apply filters to ensure a steady dividend flow and no nasty surprises, like when Anglo American scrapped its 2008 final dividend to conserve cash as commodity prices fell sharply during the global financial crisis. Commodity prices are again under pressure, most notably oil and iron ore, and dividends are threatened again. So Marriott Asset Management won’t touch commodity companies, despite the juicy payout ratio Kumba Iron Ore offers — one of the highest on the JSE. Like Sasol, Kumba’s dividend is unlikely to be as generous as it was in the past, but it’s still likely to rank among the larger payers of dividends.

A quick glance at the JSE’s All Share shows the companies that have been generous in the recent past. Kumba and BHP Billiton rank up there, as do MTN and Vodacom, with yields north of 5% on an historical basis. Marriott likes healthcare and some of the retailers, which have strong cash flow and tend to increase their prices in line with inflation or more. So perhaps include the likes of Spar, which yields 2,8%, and Life Healthcare, at 3,8%. The banks also pay decent dividends, with yields of 3,5% to 5% for the big four. The life companies are a good source too, with Liberty, Sanlam and Old Mutual all on a dividend yield of over 3%, while MMI is on 4,5%. However, these companies are geared to the market, so any correction could affect future earnings.

Forget share buy-backs, particularly for the stocks that are looking expensive. Though that’s another route for returning capital to shareholders, they don’t make sense right now with earnings multiples where they are. In fact, many managers would rather have the cash, which can be reinvested in other potential dividend growth stocks.

The Marriott fund which targets dividend growth has done well, but so have some of the exchange-traded funds that target the biggest payers of dividends — and include stocks according to their history of dividend payouts or expected payments. Taking the passive approach that ETFs offer also cuts costs, which means even more compound growth for the long term.

You can double your returns over a 40-year period just by reinvesting a couple of percent a year