Are you considering dividend investing in South Africa , which is buying shares for dividend income? Here is the low down on dividend investing.
Without a doubt, the ability of a company to pay out steady or growing dividends is often a sign of a healthy business and a good long-term investment. Thus, these dividend payments can play an important role for investors.
What is a dividend?
A dividend is a payment made by a company to its shareholders and typically represents a portion of a company’s earnings that the directors of a business have decided to pay out and not reinvest back into the company.
The benefits of dividend investing are outlined below:
1. A source of income
Dividends provide investors with cash flows which can be used to fund lifestyle requirements, or they can be reinvested. It is interesting to note that in first-world markets at present, dividend yields of multinational blue-chip companies are higher than cash and bond yields, making them an excellent source of current income.
The chart below compares the yields of a selection of multi-national blue-chip companies to the 10-year US government bond yield:
2. Inflation protection
Companies that pay dividends provide investors with an effective inflation hedge. Take, for example, an investment made in Clicks Group Limited. In 2000 a R100,000 would have bought the investor 7 905 shares in the company. Those shares would have paid the investor approximately R1 400 worth of dividends in the first year.
In 2018, that same investor would have received approximately R30 000 worth of dividends from the same number of shares. This increase in dividend income equates to an average annual income growth rate of 18.6% per annum for the past 18 years.
This growth exceeded average inflation over the corresponding period by 13.2% per annum.
It is also important to note that the value of a company increases at the rate at which its profit grows. In the same way, the value of an investment grows over time at the rate at which its income grows.
Clicks’ average annual capital growth over the last 18 years has been 16%, which corresponds with the company’s 19% average annual growth in dividend over the same period.
The chart below illustrates Clicks’ dividend and share price growth since 2000:
3. Companies that reliably grow their dividends tend to outperform the market over time
Many investors think of reliable dividend-payers as stodgy, uninteresting companies that will produce mediocre returns. This is far from being the case. Studies have shown that companies, which pay and grow their dividends outperform the market over the long term.
The table below highlights the relative outperformance over the last 20 years of some of the world’s best dividend-paying stocks when compared to the S&P 500 index.
Possible explanations for why reliable dividend-payers outperform include:
- The inherent optimism of people which drives investors to overpay for exciting and high-risk companies with volatile dividends, and underpay for certainty;
- The large percentage which dividend income contributes to an investor’s total return over the long-term; and
- The fact that reliable dividend growth typically indicates that a company has a dominant brand, a strong balance sheet and a high degree of confidence that its earnings and cash flows will continue to support future payments.
4. Managing tax
In South Africa, dividends are taxable in the hands of the investor at a flat rate of 20%. Consequently, this is an advantage for high net worth individuals in higher tax brackets.
Investing in companies that pay reliable dividends helps to reduce volatility – when the company’s share price declines, the investor will still receive dividend payments.
This article has been prepared by Preston Narainsamy, an Investment Professional at Marriott.