Active fund managers argue that they can beat the market by picking stocks that do better than the average. Risk and liquidity issues are important factors to consider here but, as an exercise to test this thesis, it is interesting to look back and see what stocks now in the FTSE 100 were the best picks 16-years ago on a total returns basis, i.e. with dividends reinvested.
Since September 1994 the best performer was Capita, a support services company. Second was Tullow, an oil exploration company, third was Sage, a software company, fourth was Antofagasta, a mining company and fifth was Next, a retailer.
The results shed light on the growth versus income argument. Traditional investors argue that the reinvestment of dividends is the key to long-term performance. This is supported by the Barclays Equity Gilts Study which shows that £100 invested in 1899 would now be worth £160 in real terms, but £22,239 if dividends had been reinvested. The performance of Capita illustrates this. In capital terms £100 grew to £3,620. Reinvesting dividends over the 18 years would have yielded an extra 36% (giving £4,911). A similar uplift is evident for Sage and Antofagasta, whilst for Next the uplift from reinvesting its dividends almost doubled total returns over the period to £2,356.
These data also demonstrate the power of compound interest. A seemingly small difference in annualised returns can lead to a vastly different final sum over a long period. Capita’s capital return is only a couple of percentage points lower than the total return (22.1% p.a. and 24.2% p.a. respectively) but by the end of 18 years of reinvesting dividends the outcome is almost £1,300 more.
Returns for Tullow, by contrast, have little to do with dividend flows and are all about growth. Oil explorers reinvest cash-flows boosted by occasional windfalls such as those experienced by Cairn in Rajasthan. (Ironically Cairn would have been in the top five, but payment of its last special dividend in March 2012 knocked Cairn out of the FTSE 100). The dividend yield for Tullow has remained very low since 2003 when the company first paid a small dividend, though it has risen since.
If dividends are that important shouldn’t investors just concentrate on high yielding stocks, where dividends are high in relation to the share price? The danger here is that…
Past performance is not a guide to future returns. The value of investments and the income from them may go down as well as up and is not guaranteed. An investor may not get back the amount originally invested. For risks relating to specific products, please refer to the relevant documentation for that product.