Do Dividends Matter?
Investors tended to ignore the returns to
be gained from dividends during the 1990’s, when share
prices generally were rising substantially. Why worry about a
3% yield when prices are going up 20% a year?
However, things look
a lot different today when a longer view is taken. A recent ABN
AMRO equity study found that over the past 80 years dividends
accounted for 60% of an investor’s total
return.
During the past six and a half years share prices
on the London Stock Exchange showed only a marginal increase with
the FTSE All Share Index climbing back in April this year to the
level it originally reached in August 1997. So, for the average
investor, capital returns have gone up and down but basically
nowhere. However, the dividend return on them has been 19%
if reinvested.
Over the same period the FTSE 350 Higher yielding
index (shares with above average yields) rose 40% whilst the
lower yielding index (shares with below average yields) fell by
23%. Therefore, it makes sense for investors to pay attention to
dividends for the following reasons:
Value
One measure of the value of an asset is
the income stream derived from it. The only income stream you derive
from equities is their dividend. Expressing the dividend on a share
as a percentage of its price (the yield) is a good way of assessing
whether the shares are cheap or expensive. Most company boards
hate to cut their dividend (it is an admission of failure) so they
try to make sure that they set the dividend at a sustainable level.
For this reason dividends are far less volatile than either profits
or share prices. So, a good share is one where the dividend has
increased consistently, where the yield is high and prospects okay.
Such a share may well be out of favour but in fact it still represents
good value. Investing for yield is a good way of avoiding being
swept up in investor crazes. The proof of the pudding is in the
eating and the dividend is the only meal on offer!
Transparency
Dividends can’t be faked.
They represent cash, in contrast to stated “profits” and
chairmen’s
statements. Dividends are not subject to the vagaries of changing
accounting policies and so not subject to all sorts of back adjustments
and revisions. Those adjustments that do have to be made (for share
issues) are easily done. The long term dividend performance is
the best guide you’ve got to a company’s unadulterated
track record.
Discipline
Having an obligation to
pay shareholders a sustainable and growing dividend year in,
year out imposes discipline on a board. A recent study in the
US showed that the bigger the share of profits a company pays
out in dividends the better its future earnings growth. One
explanation for this is that the company paying larger dividends
tends to be a great deal more discerning about the investment
projects it takes on because it doesn’t have a surfeit of spare cash.
Another explanation is that the higher the payout ratio the more
confident the company in its future. Dividends make Boards sweat – somebody
needs to!
Out-performance
A study by Standard
and Poor’s in the
US showed that companies paying dividends outperformed
non-payers from 1980 to 2003. The performance of the FTSE
High Yielders index over the past six and a half years
tells a similar story. After a lengthy period of ignoring
income returns in favour of hoped-for capital gains, investors
are once again paying attention to dividends. So should
you!
© Dividend Analysis, 2004
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