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.
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