They are not as exciting as the rise or decline of share prices, but dividends can provide a valuable and steady stream of income for investors, says Rian Brand, portfolio manager at the Sygnia Group.
They are not as exciting as the rise or decline of share prices, but dividends can provide a valuable and steady stream of income for investors, says Rian Brand, portfolio manager at the Sygnia Group.
1. In the buzz around share prices, we should not fail to appreciate the returns dividends offer
Dividend growth investing can provide both current and future income when choosing a company that offers consistent and stable returns.
But however attractive dividends as a steady flow of passive income may be, they are just not as sexy to talk about when compared to the excitement that share movements can offer.
“We don’t hear about dividend growth on the news, but the sharp growth or declines of share prices will definitely feature. Dividends are easily overshadowed by all the noise around share prices,” says Brand.
Dividend-paying companies usually announce an interim or annual distribution. The proceeds can then be utilised as a passive income, or reinvested. Apart from the distribution, dividend-paying companies also offer investors the opportunity to profit through share price appreciation.
Brand warns however that there are, as with any stock, some risks to keep in mind. Even diligent dividend-paying companies sometimes stop or cut the distribution. Take Telkom for example, which stopped in 2011 and started paying again in 2015. If you are dependent on your dividend proceeds for an income, the sudden loss of income can be a blow to your financial well-being.
He believes the best choice for dividend growth investments are companies with a progressive dividend policy, those that pay increasing dividends. However, the investor should not stare themselves blind against the dividend policy, since companies may be forced to change the policy during tougher times. An investor can however get some comfort from a track record of increasing dividends.
2. Unlike bond coupons, dividends can increase (or decrease) over time
When buying a typical bond, the face value of the bond does not change over time. Because of inflation, the value of the capital that will be returned at the end of the life of the bond is therefore worth less than when the bond was purchased. The yield on a bond thus needs to compensate the investor for the loss of value by offering a higher yield. If the yield on a bond is 9% per annum, but inflation is 6%, the real return is only 3%.
In the case of a dividend, it can be expected that over time the company paying the dividends will grow. Investors thus do not have to be compensated for the loss of value of the initial investment from inflation. A lower dividend yield can therefore be expected. For instance, at the time of writing, the historic dividend yield of the SWIX is 2.9%.
3. If dividends are too high, it can adversely affect the sustainable growth rate of a company
A high dividend yield is often seen as an indicator of the health of a company. This is however not necessarily true. The management of a company needs to choose how the earnings a company generates is to be employed. As companies grow, they need capital for expanding infrastructure and additional working capital. If too much earnings are paid out as dividends, there will not be sufficient capital to expand operations and the company would have to look to other sources of capital.
This concept is captured in the sustainable growth rate. The sustainable growth rate can be calculated by multiplying the earnings yield with the percentage of earnings not paid out as dividends. The sustainable growth rate is the maximum rate a company can grow at over an extended period without tapping other sources of capital. If the management of a company is expecting growth, it would not make sense to pay out a dividend, just to have to tap the market for capital again later.
An over reliance on dividend yield as a measure of the health of a company is therefore ill-advised. There are companies who never or rarely pay dividends as they plough everything back into company growth. Well-known groups locally are Curro and offshore Amazon and Berkshire Hathaway. “This doesn’t mean they can’t offer an income stream for the investor. Companies that don’t pay dividends are not better or worse than other companies, they may just be in a different growth stage. If an investor needs the income, they can simply sell a small proportion of the shares held,” says Brand.
4. Dividends are taxed
Since 2012, dividends tax is levied on shareholders when they receive dividends. The tax is currently 15%. If you don’t want to have your investment income taxed, options are to keep it in a tax-free vehicle such as a tax-free savings account or in a pension fund, as it does not attract tax during the investment period.
5. Dividend stocks typically fall less during bear markets
“In the aftermath of the 2008 financial crisis we saw that high dividend companies outperformed very handsomely. Not necessarily because they are dividend-paying companies, but possibly because they are in a defensive sector.”
Brand says defensive sectors, which are not as dependent on larger economic cycles, include for instance; brewing companies. “If people don’t celebrate, they drown their sorrows. This is compared to a company such as Nampak; a packaging group that are more dependent on economic growth. When the economy suffers, the need for packaging also shrinks.”
The last word
Finally, reinvest your dividend income for the best growth. Brand says if an investor just left all his dividends earned on the SWIX index since January 2002 in the bank, the value of his investment today would have been roughly 16% less than if he reinvested.
https://www.sygnia.co.za/images/default-source/news-insights/rian-brand.jpg?sfvrsn=0
**RIAN BRAND
PORTFOLIO MANAGER, SYGNIA GROUP**
Rian is a portfolio manager with 7 years’ experience in the South African asset management industry.
Prior to joining Sygnia in 2008, Rian was a software consultant at Kennedy Brand Consulting where he spent three years. Previous to this he spent five years as a software engineer at Azisa and Flextronics South Africa. Rian started his career as a design engineer at Thales Advanced Engineering from 1998 to 1999.
SYGNIA GROUP
The Sygnia Group comprises six operating companies; Sygnia Life, a life assurance company, Sygnia Asset Management, a licensed asset management company, Sygnia Collective Investments, a unit trust company, Sygnia Financial Services, a LISP, Sygnia Securities, an execution-only stockbroker and Sygnia Systems, a financial software development company.