My Dad, who is now in his 80s, still loves it when he gets a dividend cheque in the post, especially if the cheque has grown by double digits compared to the previous year. Given his long term “buy and hold” approach, he almost pays more attention now to the growth in the dividend cheques than the daily movements in share prices.
This got me thinking about his approach, and how it can make even more sense today for investors looking for income to be invested in quality companies that can be expected to grow their profits over time and pay decent dividends.
When studying “Modern Portfolio Theory” at college, it impressed upon us that for every unit of risk taken an investor could expect a certain rate of return. In essence, if you took a high level of risk, you could expect a high return and a low level of risk would warrant a low level of return. However, what that lecturer failed to anticipate all those years ago was the Global Financial Crisis and the subsequent action of central banks.
With Euro interest rates in negative territory, those investors looking to take a low level of risk do not get a low level of return, they get a NEGATIVE return on their money after taking inflation into account. This situation creates a headache for many investors looking for regular income. Traditionally bank deposits and government bonds were some of the key income generators used by investors.
Often in our industry, we like to make products “complicated” and to incorporate exotic strategies to try and impress potential investors. However, I believe simply investing in quality dividend paying companies can form a key part of the solution for clients looking for income (especially ARF clients).
Whilst we can debate ESMA ratings and client risk profiling, the bottom line is that many investors require an income and in order to achieve an income they are going to have to TAKE RISK. The challenge for advisors and brokers is to help clients understand the risks.
Equities are risk assets and share prices often move around a lot, particularly in the short term. But looking at the medium term (say 6 years), as an asset class, equities tend to produce positive returns. Based on historic data on the S&P500 between 1928 and 2015, there is a 93% probability that over any 6 year period you would have made money by being invested in the market. This statistic often surprises many investors.
We like dividend paying companies because of their quality characteristics:
- Dividends offer investors an attractive source of income relative to other asset classes such as bank deposits and government bonds
- Dividends can be increased and hence help to protect against the impact of inflation
- Dividends impose financial discipline upon management teams
- But most importantly, dividends are the key component of total equity market returns over the medium term.
An example is a company such as Accenture, which is exposed to the growth of digital services and cyber security for many of the world’s largest companies. If you had of invested $50,000 in Accenture at the end of 2005 (the company came to the market in 2005), then your dividend cheque in 2006 would have been $600. Assuming you still owned those shares, that dividend cheque would have growth to $4,800 last year.
I expect Eurozone interest rates to remain at less than 1 % over the next five years. Based on this assumption, quality companies that pay out a decent dividend and which grow their dividend each year look very attractive to me. Those sorts of growing dividend cheques should keep my Dad happy!
Author: James Forbes, Head of Investment Solutions at Goodbody Asset Management www.goodbody.ie
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