Why A Blind Focus On Dividends Can Destroy Wealth...

31st May '12 by Portfolio Review

2 comments 4921 reads

At the risk of sounding a bit like a broken record, dividends matter. It’s boring and a bit predictable but dividends do provide one of the few certainties in the ever-so risky world of investing – that regular, bankable dividend cheque can be a lifesaver.

If you do need any reminding of this ‘wisdom’, take a peek at the chart below which is from index research firm S&P.It looks at dividends’ contribution to 10 year annualised returns for a number of very broad market indices (BMI). At one end we can see that dividends contributed just 21.6% of the total returns for S&P’s emerging markets indices whereas in Europe that number rose to a whopping 60%. The best ‘big picture’ number is for the S&P Global BMI index which pretty much covers ALL major investable equity markets globally – dividends provided 44.5% of total returns.

In sum this data from S&P suggests that dividends matter a great deal.

Chart – contribution of dividends to total 10 year annualised returns for major S&P indices

The S&P data also goes on to look at their own suite of indices where the companies in an index are skewed towards those that regularly increase dividends. Our favourite S&P dividend focused index is the Aristocrat based Dividend Opportunities range which track companies that have regularly increased payouts for the last 5 to 10 years – according to S&P, the global opps index has regularly outperformed the equivalent non-dividend focused index (the Global Ex-U.S. BMI) “in eight of the 10 calendar years ...and on an annualized basis over the last one, three, five and 10 years. On an annualized basis over the 10 years ended December 30, 2011, the S&P International Dividend Opportunities Index total returns were 12.73% while the S&P Global Ex-U.S. BMI total returns were 7.43%.”

The bottom line ? Dividends matter and there is some strong evidence to suggest that weighting both your index and your fund trackers towards companies that prioritise dividends is a fruitful strategy.

But there’s a catch...

And it’s a very important catch – a blind focus on dividends without looking at any other fundamental measures can also potentially destroy your hard-earned wealth.

Many investors’ take the simple idea of buying high yielding stocks and then apply it on an individual stock by stock basis, buying reliable ‘blue chip’…

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emptyend

31st May '12

But there’s a catch...

And it’s a very important catch – a blind focus on dividends without looking at any other fundamental measures can also potentially destroy your hard-earned wealth.

Many investors’ take the simple idea of buying high yielding stocks and then apply it on an individual stock by stock basis

I've been banging on about this for many years - since well before the banking crisis when the lemmings were falling over themselves to buy those "high-yielding" bank stocks. So I was very interested to see an article in the FT this week on the topic of the drag on share price performance that results from carrying long-term cash balances that are well in excess of what the business requires!

This section particularly took my attention........

“Companies which chose to keep excess cash reserves at hand for longer than a year were penalised by the market,” said Anna Faelten, deputy director at the M&A Research Centre at the Cass Business School and co-author of the study. “Our evidence shows this strategy is the worst way of managing additional liquid funds.”

Share buybacks and acquisitions provided shareholders with the highest average returns of 7 per cent and 11 per cent respectively on an index-adjusted basis, according to the report. Companies that spent their “excess” cash on dividends returned on average 3 per cent over the subsequent three years.

.............because it makes clear that shareholders do much better overall if companies spend their money on buybacks and/or acquisitions than simply returning the cash to shareholders via dividends.

Now I'd guess there is the chance that the sample is in some way skewed - but IMO this is powerful evidence against dividends continuing to enjoy the primacy that some shareholders seem to attach to them as a means of returning value to shareholders!!!

I'd also agree with the observation of one analyst regarding buybacks......

“There are companies which do buybacks correctly, but sadly they are in the minority,” said Andrew Lapthorne, a strategist at Société Générale. “The execution price of the buyback is always going to be wrong, as you tend to execute the buyback when your cash flows are strong. If that is happening, then your share price is elevated.”

...though I find it interesting...very interesting.....to see some practical examples in the market at the moment which completely disprove his closing assumption that there is a close correlation between cashflow and share price. There SHOULD be, of course....but simple observation shows that this isn't always the case!!

harryr

5th Jun '12

The real trick is to buy tiny growth stocks that are about to make a profit , then within a year or two start paying a divi.
One then gets a re rating on first profit, re rating on first divi and rerating as divi grows year on year.
After say four years divi each year = the price you bought the stock for on day one.

Why a Blind Focus on Dividends can Destroy Wealth...

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