THE FORGOTTEN DARLING
Not much is said about dividends in modern days however, especially in a world where share prices go from 0 to 100 in less than a second. It’s all about capital growth or the rerating of a share’s price as the accountants expect the next growth market or life-changing service or app to sustain 20% earnings growth into perpetuity. Share prices sky rocket and trade at premium valuations because of these elevated expectations for future (uncertain) earnings growth. Despite numerous research studies highlighting the fact that dividends and growth in dividends explain in excess of 90% of a share’s total return over time, we tend to spend 90% of our time talking about capital return and not much else. So why are dividends so important?
1. Investments that never yield cash are extremely risky. What is the difference between an ounce of gold or a piece of art or a share in a company that does not pay a dividend? The value depends on what someone else would be willing to pay and how do you determine that value if not relative to an underlying cash earnings stream?
2. It has been shown that growing dividends are a reasonable predictor of future returns. Numerous studies refute the statement that low payout ratios lead to superior growth. In fact, many global leading companies have maintained high payout ratios while still growing earnings at a healthy rate. Locally, for example, Standard Bank has been averaging a 50% payout ratio while still growing its dividends by 17% per annum.
3. Dividends offer a margin of safety. High dividend yielding shares tend to be more defensive in nature and outperform during times of crises (the opposite is also true though)
4. Margin of safety and subsequent lower capital volatility ensures the positive effect of compounding working in your favour (a consistent 10% per annum for 3 years deliver a 33.1% compound return while 20%, then -10% and 20% again compounds to 29.6% - remember Warren Buffet’s rule about not losing money?)
I believe it is important to invest in a combination of productive assets that deliver a consistently growing earnings (dividend) stream, ideally in the form of a multi-asset class portfolio invested in high dividend yielding equities, listed property, preference shares, fixed income securities and offshore investments.