FYI | Aug 30 2017
By Peter Switzer, Switzer Super Report
Here are the compelling reasons why I buy dividend paying stocks
The second-half of reporting season for 2016-17 will and should be remembered for the dividends. Telstra flagged a cutting, CBA raised it and Fortescue became one of the best dividend payers in the market, with one expert claiming it’s a 10 percenter!
Of course, the dividend yields calculated by stock market scribes are based on the current dividend in cents per share and the prevailing market price. However, many of you reading this will have bought some of the favourite dividend stocks at much lower prices and so your dividend yield is much higher. If you fell into CBA in the $90, or Fortescue when it was $6.88 in the February region, then your yield is lower.
But I don’t want to get bogged down on what your yield is, but more make the case that chasing dividend stocks is and will always be a damn great investment strategy. Sure, the timing can add to or deduct from the overall gain but, over time, these stocks are like properties that deliver capital gain and rents that we call dividends. And yes, like property, you can buy at the top of the market but, over time, the prices can go, and generally do go, higher.
In reality, I’d trust a property in Paddington in Sydney or Albert Park in Melbourne more than a lot of individual stocks, but when you put 10 or 20 good dividend-paying stocks together, you have something to compare to a great property, which comes with one great benefit — no tenants!
And just like property tricks and traps, you do have to be careful of some dividend traps. So even though BHP tripled its dividend, and Rio as well as Fortescue doubled theirs, you always have to remember that you don’t buy mining stocks for their dividends. That said, my expert buddies think we can trust these miners and their payouts for at least one more year!
I think an enduring lesson about dividends that should be underlined at this time came from Matthew Ross, the equity strategist at Goldman Sachs, who noted: “Telstra’s decision to cut its dividend and introduce a variable dividend policy leaves the market without a single high-yielding stock that hasn’t cut its dividend at least once in the past decade.”
Of course, the GFC forced a lot of those cuts and that was a serious financial challenge. In many cases, the cuts were short-lived and ensuing rises quickly made up for those cuts our companies had to have.
All this celebration about dividends leads me to recall a story written by AMP Capital’s Shane Oliver back in 2014, which he made reference to last Thursday on my TV show. Shane’s a dividend lover and has actually written that “dividends are cool”, which contrasts with other experts, like Roger Montgomery, who insists that companies that overpay dividends have nothing better to do and are lazy operations that are giving up on capital growth prospects by giving the owners/shareholders too much money back.
Shane begs to differ.
Here’s a history lesson for you: Shane reckons that until the 1950s, Aussie investors were long-termers, who went long stocks for the dividends. “This changed in the 1960s as bond yields rose on the back of inflation and investors started to shift focus to capital growth,” he reported. “However, thanks to the volatility seen over the last decade or so, and an increased focus on investment income as baby boomers retire, interest in dividends has been on the rise.”
A few years back, Australian companies paid out a high proportion of earnings as dividends — around 75% — and have averaged around this mark since the late 1980s. In contrast, dividend payout ratios range from 31% in Japan to 49% in the UK.
Of course, dividends here are made more attractive because of the franking credits, which can deliver big ‘tax refunds’ for retiree-investors.
Here are Shane’s best arguments for loving, respecting and investing in dividend-paying companies:
- For the US share market, it has been found that higher dividend pay outs lead to higher (not lower) earnings growth. This chart below shows that for the period since 1946, whenever US companies have paid out a high proportion of earnings as dividends (the horizontal axis), this has tended to be associated with higher growth in corporate profits (after inflation) over the subsequent 10 years (vertical axis).
- Higher profit growth and the paying of dividends actually tends to go hand in hand and is a characteristic of companies that stand the test of time.
- When companies retain a high proportion of earnings, there is a tendency for poor investments, which subsequently leads to poor earnings growth.
- High dividend pay outs are indicative of corporate confidence about future earnings (otherwise companies wouldn’t feel comfortable in paying them).
- High dividend pay outs are a positive sign, as they indicate earnings are real, i.e. backed by cash flow.
- Decent dividend yields also provide security during uncertain times. As can be seen in the next chart, dividends provide a stable contribution to the total return from shares over time, compared to the year-to-year volatility in capital gains. Of the 11.8% pa total return from Australian shares since 1900, just over half has been from dividends.
- Investor demand for stocks paying decent dividends will be supported over the years ahead, as more baby boomers retire and focus on income generation.
- And here’s another strong case from Shane: “With the scope for capital growth from shares diminished thanks to relatively high price to earnings ratios compared to 30 years ago, dividends will comprise a much higher proportion of total equity returns than was the case in the 1980s and 1990s globally and in Australian shares up until 2007. Around half of the total return from Australian shares over the next 5 to 10 years is likely to come from dividends, once allowance is made for franking credits.”
The next chart shows the impact of dividends on the total return from stocks. I’d rather be on the blue line than the brown one, which nets out the dividend effect.
And the next chart shows what happens to $100,000 in a term deposit (brown bars) versus dividends from stocks (blue bars). Again, the case for dividend stocks is so easily portrayed.
This chart and the one above by themselves explain why I wanted to create a Dividend Growth Fund, with some 30-40 great dividend-payers. Our next dividend should be a ripper after such a good reporting season for dividends.
I know you can do really well investing for growth but it’s a riskier game. When it comes to my money, I like Warren Buffett’s two most important rules of investing: “Rule No. 1: Never Lose Money. Rule No. 2: Never Forget Rule No. 1.”
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
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