The answer to the investor’s prayer?
To start with, a short poem to help set the scene.
“A cow for her milk,
A hen for her eggs,
And a stock for her dividends.”
The author is John Burr Williams and, whatever you think of his poetry, when he wrote this in 1938 his thinking was at the very cutting edge of investment theory.
And, as the tornado amongst the markets has now receded a bit, I thought a return to the building blocks of investing might be useful.
Dividends are useful for all sorts of investors and companies alike. However, the most important aspect of the dividend is its contribution to the long-term growth of the stock you hold.
Without wishing to rub salt into recent wounds, bank shares were considered a good bet in many cases precisely because of their high dividends.
The Financial Times asserted recently with regard to one stock that: “Dividends are reassuringly honest.” Honest, that is, if they are payable and sustainable.
Honest also in that they cannot be massaged like earnings, which is precisely why they are used by managements to signal corporate strength.
So when, as now, markets go mad, investors will tend to rush back looking for, at the least, ‘a good dividend’ as opposed to things like ‘momentum’, ‘liquidity’ or an exciting stockbroker's story.
When times are uncertain a company’s cash flow comes very sharply into focus as a driver of returns, rather than short-term capital appreciation of the share price in the markets.
The enormous amount of market turmoil currently will, of course, change the focus in most boardrooms.
They will be concentrating on how to keep the shareholders on board and happy.
And, whilst the talk of cutbacks may be high on the agenda, the one item that will be left untouched is the payment of dividends. Just ask BP. But do dividends make all that much difference? Well, if you look at some base figures from say 1900 to date, there is a marked difference on the overall return.
For the UK market the return on an annual basis over the period without dividends is 4.9%. But with dividends reinvested it is 9.8%.
Although there are many other ways of ‘skinning the investment cat’ that have met with varying degrees of success, they tend to work over limited time spans and in particular market conditions.
This is fine if you can spot the moment to switch.
Not easy, as evidenced by the fact that most people did not spot the onset of the recent fall.
Another point to note here is that companies are working in global markets and are subject to global market trends that do not recognise any geographical boundaries.
So you need to think about dividends on an international and not just a UK scene. The other obvious reason for so doing is that this will diversify your portfolio.
So, as I have often stated before, you need to focus on investing basics and these have not changed despite almost unprecedented storms in the markets over recent weeks.
A revisit to both your investment goals and your time horizons will also help keep you very focused.
Nicholas Watts is an independent financial adviser with Positive Solutions Financial Services which is regulated by the Financial Services Authority. To contact him, use the website www.realwealthmanagers.co.uk.