For investors in equities there is nothing quite as important as notification that a hard dividend payment has been deposited into their accounts.
That transaction goes to the heart of what prudent and conservative investors should value most when managing and developing a portfolio of shares.
Yet, dividends are often left at the bottom of many media reports when companies release their results. Sales momentum, operating profits and news about corporate acquisitions and disposals tend to dominate the headlines. For those who care more about creating long-term shareholder value I always advise a close eye on the paragraph covering dividends.
It is here that you find out the data regarding the cash sum which will be distributed to shareholders. Often you can find more details on what a management team or board are thinking when determining an appropriate dividend policy.
Let’s start with first principles. A dividend yield is a helpful place to begin. I screen for yields at 3% or above because such a return is immediately beating inflation, a key hurdle for anyone generating real value. Next, how well is that dividend covered by the company’s annual net after tax cash profit? Cover of at least two times and preferably more implies the risk of any future dividend being slashed is minimised.
A perusal of the company’s business model, its strategy and its future plans is a further requirement. Buying a high yielding share in, for example, a telephone box manufacturer would be foolish as the business has no long-term future.
Assuming we now have a good quality business, a yield above 3% and cover of over two times what next? Digging in to the track record of the company analysed, and in particular reading carefully any comments from the board or management team, is a worthwhile exercise.
I like to find a dividend record which shows consistent growth in the annual payment. That points to a dividend policy which matches or beats inflation. Imagine you had bought a share 10 years ago on a 3% dividend yield and the company had grown that dividend by 5% per year.
Such a policy would have comfortably beaten inflation whereas a static payout would have eaten away your nominal returns.
Picking out five to 10 companies that offer these attributes is a conservative approach to creating an investment fund that is not overly time-consuming for those busy with their working lives. Putting money to work in these businesses is the next challenge.
One option is to allocate a sum of cash each year which is invested in your chosen companies. This risks exposure to equity markets at a single point in time. If stockmarkets are in a strong bull run your single investment occurs at a time when share prices could be about to falter. An alternative is termed “dollar average investing”. This approach uses regular and consistent investments which take place irrespective of bullish or bearish markets. Long-term studies have shown this is a clever way to create value and minimise the downside in volatile markets.
Equipped with these tools an investor can now focus on how best to develop his or her portfolio. Dividend cheques have to be allocated. Do you leave them in cash, acquire newly-investigated companies or reinvest the proceeds in the existing group of stocks owned?
Should dividends be diverted to property or bonds? These decisions should also be assessed through the prism of the dividend zealot. Can they replicate the income generating, value creating attributes that flow from a well constructed equity portfolio? Addressing these matters is a key challenge for anyone who covets a worthwhile nest egg.
* Joe Gill is director of corporate broking with Goodbody. His views are personal.
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