Dividends

Dividends

Photo by Nick Pampoukidis on Unsplash

Receiving a cash dividend has historically been seen as an important part of the investment return received from owning a share in a company.  This has been especially true in the UK market, which when compared to the US market, tended to pay a higher cash dividend to investors. 

It’s not surprising that investors like to receive dividends, whether to meet their expenditure needs or just to reinvest.  J D Rockefeller is reported as saying, ‘Do you know the only thing that gives me pleasure?  It’s to see my dividends coming in.’  I’m sure a lot of investors feel the same way about their investment portfolios.

We can all still relate to these words, despite their utterance over a century ago.  Be it a privately-owned business or publicly-listed stock, dividends come as part and parcel of owning a portion of a business.  Cash dividends have long been an effective tool used to attract investors to a company’s shares – as the saying goes, ‘a bird in the hand is worth two in the bush’.

But however much we like to receive cash dividends as part of our investment return from companies, it might not be wise to become too attached to receiving them.

Dividends have also historically been a way to disseminate information – a change in a company’s dividend could hint at a change in its financial health.  In a world becoming increasingly dominated by information, mostly available at our fingertips, the power of the dividend, from this perspective at least, has diminished.  Also, corporate finance departments have other tools at their disposal, such as share buybacks, that have become increasingly popular.

Such phenomena, in addition to perhaps a shift in investor sentiment, have resulted in a reduction in the number of firms paying regular cash dividends to shareholders.  The volume of dividends, however, hasn’t necessarily decreased, meaning that dividends are concentrated in a smaller number of companies.  Therefore, as I’ve said in previous blogs, trying to align a portfolio towards dividend-paying companies by using a dividend-targeting strategy might result in a less diverse portfolio.  In turn this has the potential to have a higher exposure to risk than a more diversified one.  We all know diversification is the only ‘free lunch’ in investing.

Another question you might ask is whether lower dividends mean lower returns.

Not necessarily.  Once a stock goes ex-dividend, it’s price decreases by the amount of the dividend, everything else being equal.  Not issuing a dividend means that the cash remains in the company and is still part of the shareholder’s claim on assets, i.e. the price reflects the cash retained and the price doesn’t change.

Figure 1: Illustration of the impact of a dividend on stock price

Source: Albion Strategic Consulting

So on this basis does it matter what your portfolio yields from dividends?

Not really.  At Bloomsbury, we adopt what is called a ‘total return’ approach to investing.  We are agnostic to companies’ dividend policies and instead structure diversified portfolios with a focus on risk exposures.  A portfolio will usually generate some income from dividends each year, and sometimes some capital appreciation too. However, as Figure 1 demonstrates, it doesn’t matter where that return comes from.  

It’s unlikely that anyone drawing cash out of the cash machine stares at two £20 notes and wonders, which of these came from interest and which came from the original capital?  The return from an investment portfolio is just return; it doesn’t matter how it was generated.

Cheers

Charles

This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.  Your capital is at risk when investing.  Past performance is not a reliable indicator of future results.