In­vest­ment: To­tal re­turn of a stock an im­por­tant fac­tor to con­sider

Div­i­dends have had a great im­pact on the JSE’s to­tal re­turn over the years, but in­vest­ing only in shares that pay large div­i­dends doesn’t guar­an­tee suc­cess.

Finweek English Edition - - MARKETPLACE - By Schalk Louw ed­i­to­rial@fin­ Schalk Louw is a port­fo­lio man­ager at PSG Wealth. *fin­week is a pub­li­ca­tion of Me­dia24, a sub­sidiary of Naspers.

in­vest­ing in shares isn’t al­ways as easy as it seems. On the one hand, you have fa­mous in­vest­ment ex­perts who will point out that ac­cord­ing to their in­vest­ment recipe, div­i­dends, and more specif­i­cally the growth at­tached to com­pany div­i­dends, is the key to suc­cess. On the other hand, you have equally suc­cess­ful in­vestors who will show you that their key to suc­cess lies in in­vest­ing in com­pa­nies that do not pay out prof­its in the form of div­i­dends, but who in­vest that cap­i­tal in fur­ther ex­pan­sions and growth.

War­ren Buf­fett loves to in­vest in com­pa­nies which are able to pro­vide growth on div­i­dends over time. How­ever, his own com­pany, Berk­shire Hath­away, doesn’t pay out any div­i­dends, and rather chooses to in­vest that cap­i­tal. Does that make Berk­shire Hath­away a bad com­pany to in­vest in? Not at all.

The one dis­ad­van­tage of the huge em­pha­sis on high div­i­dend-pay­ing shares is that in­vestors are of­ten so fo­cused on the pay­ment and growth of th­ese div­i­dends that they com­pletely for­get about the to­tal re­turn on the un­der­ly­ing in­vest­ment. But what ex­actly does to­tal re­turn (TR) mean?

The TR on a share, for ex­am­ple, is as ob­vi­ous as the term sug­gests – the to­tal re­turn on that par­tic­u­lar un­der­ly­ing in­vest­ment. The TR on shares that do not pay out div­i­dends is cal­cu­lated by sim­ply de­ter­min­ing the dif­fer­ence be­tween cost and cur­rent pric­ing. In order to de­ter­mine the TR on shares that do pay out div­i­dends, how­ever, you need to cal­cu­late the amount in div­i­dends paid out and rein­vested in your ex­ist­ing port­fo­lio, in ad­di­tion to the dif­fer­ence be­tween cost and cur­rent pric­ing.

The TR on a share/com­pany is driven mainly by growth on earn­ings, div­i­dends and, of course, changes in val­u­a­tions. If we have a look at one of the most suc­cess­ful com­pa­nies on the JSE for the last two decades, namely Naspers*, you will note that not un­like Berk­shire Hath­away, Naspers isn’t fa­mous for pay­ing out div­i­dends. The com­pany is more fo­cused on rein­vest­ing share­hold­ers’ cap­i­tal. The one main ad­van­tage of a com­pany that doesn’t rein­vest all of its prof­its by pay­ing out div­i­dends is that it helps share­hold­ers to clear a few chips off the ta­ble ev­ery now and then, so to speak. The JSE lost 30% or more of its value three times over the last 20 years, in 1998, 2002 and 2008 re­spec­tively. Over the same pe­riod, Naspers ex­pe­ri­enced a cor­rec­tion of 30% or more in 1997, 1998, 2000, 2001, 2002, 2007 and 2008. Take note that this only in­cludes a price drop of 30% or more. If we ad­just this to 20% or more, the re­sults would be even more shock­ing. Whether you be­lieve in div­i­dends or not, they re­main a huge com­po­nent of the JSE’s to­tal re­turn. This is clearly vis­i­ble in the ta­ble be­low, where div­i­dends have made up an av­er­age of nearly 47% of the FTSE/JSE All Share In­dex’s to­tal re­turn over the decades since the 1960s. An in­vest­ment of R100 in 1967 would be worth roughly R296 000 today if you had rein­vested div­i­dends, while it would have been worth only R38 645 if you had with­drawn all of your div­i­dends. As great an im­pact as div­i­dends have had on the JSE’s to­tal re­turn over the years, it still doesn’t of­fer any guar­an­tees for the suc­cess of such an in­vest­ment in the fu­ture. Buy­ing shares based only on their high pay-out abil­ity re­mains a one-di­men­sional strat­egy. I would rec­om­mend in­vestors com­bine this strat­egy with other suc­cess­ful meth­ods, ra­tios and in­vest­ment aids. A gourmet meal, af­ter all, isn’t com­posed of only one in­gre­di­ent.

An in­vest­ment of R100 in 1967 would be worth roughly R296 000 today if you had rein­vested div­i­dends.

War­ren Buf­fett Busi­ness mag­nate and in­vestor

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