Dividends can be highly sexy

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When talking about shares, the aspect that tends to get the most attention is price growth. Discussions around the braai are about how the Naspers share price more than doubled between the start of 2015 and the end of 2017.

In general, investors underestimate just how significant dividends can be. As Paul Stewart at Bridge Fund Managers points out, over long periods, earning and reinvesting dividends produces a growing portion of a portfolio’s total return.

“For example, if you deconstruct the performance of the Old Mutual Investors Fund, which has the longest track record of any equity fund in the South African market, 60% of its long-term total return comes from dividends and growth of dividends over time.

The longer you invest for, the more important the dividend element becomes.

“Over very long periods of time, 30 years or more, the dividend you receive plus the growth in that dividend is what drives the total return,” Stewart says.

This is one reason why dividend investing is such a popular strategy. Companies that pay sustainable and growing dividends generate growth that is compounded over time. Dividends are also a good measure of a company’s health. Earnings are sometimes unreliable numbers.

“The dividend, by and large, is not a fudgeable number because you physically get paid that money as a shareholder,” Stewart points out.

With a few caveats – like you don’t want dividends paid out of borrowings – one can assume that companies able to pay dividends consistently are running high-quality operations.

“If you look for companies that grow their dividends sustainably, you tend to get companies that are cash flush, well run, have strong balance sheets, and are able to go through more difficult times and continue to operate,” says Lourens Coetzee at Marriott.

“That adds to the quality in your portfolio and the certainty of outcome.” The downside risk in these companies also tends to be lower than the general market. “If a company is on a 4% dividend yield and the market believes it will grow its dividend by 8% or 9% per annum over the next few years, it’s very rare that you would see that dividend yield going to 8% because the share price would have to halve,” Stewart says. “This is because these are generally stable, quite large, cash generative businesses. “However, the share prices of companies that pay low dividends or no dividends can have enormous accidents if they miss their earnings or a merger and acquisition deal doesn’t pan out.”

Such firms consistently run top-quality operations

The Marriott Dividend Growth Fund, which targets a reliable and growing dividend yield ahead of capital growth, has been the top-performing local equity fund over the past decade.

The Bridge Equity Income Growth Fund has been a top 10 performer over the last five years.

“Half the reason is that these are businesses that sell basic services or necessities,” Coetzee explains.