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Do Dividends Matter?
Investors tended to ignore the returns to be gained from dividends during the 1990’s, when share prices generally were rising substantially. Why worry about a 3% yield when prices are going up 20% a year?

However, things look a lot different today when a longer view is taken. A recent ABN AMRO equity study found that over the past 80 years dividends accounted for 60% of an investor’s total return.

During the past six and a half years share prices on the London Stock Exchange showed only a marginal increase with the FTSE All Share Index climbing back in April this year to the level it originally reached in August 1997. So, for the average investor, capital returns have gone up and down but basically nowhere. However, the dividend return on them has been 19% if reinvested.

Over the same period the FTSE 350 Higher yielding index (shares with above average yields) rose 40% whilst the lower yielding index (shares with below average yields) fell by 23%. Therefore, it makes sense for investors to pay attention to dividends for the following reasons:

One measure of the value of an asset is the income stream derived from it. The only income stream you derive from equities is their dividend. Expressing the dividend on a share as a percentage of its price (the yield) is a good way of assessing whether the shares are cheap or expensive. Most company boards hate to cut their dividend (it is an admission of failure) so they try to make sure that they set the dividend at a sustainable level. For this reason dividends are far less volatile than either profits or share prices. So, a good share is one where the dividend has increased consistently, where the yield is high and prospects okay. Such a share may well be out of favour but in fact it still represents good value. Investing for yield is a good way of avoiding being swept up in investor crazes. The proof of the pudding is in the eating and the dividend is the only meal on offer!

Dividends can’t be faked. They represent cash, in contrast to stated “profits” and chairmen’s statements. Dividends are not subject to the vagaries of changing accounting policies and so not subject to all sorts of back adjustments and revisions. Those adjustments that do have to be made (for share issues) are easily done. The long term dividend performance is the best guide you’ve got to a company’s unadulterated track record.

Having an obligation to pay shareholders a sustainable and growing dividend year in, year out imposes discipline on a board. A recent study in the US showed that the bigger the share of profits a company pays out in dividends the better its future earnings growth. One explanation for this is that the company paying larger dividends tends to be a great deal more discerning about the investment projects it takes on because it doesn’t have a surfeit of spare cash. Another explanation is that the higher the payout ratio the more confident the company in its future. Dividends make Boards sweat – somebody needs to!

A study by Standard and Poor’s in the US showed that companies paying dividends outperformed non-payers from 1980 to 2003. The performance of the FTSE High Yielders index over the past six and a half years tells a similar story. After a lengthy period of ignoring income returns in favour of hoped-for capital gains, investors are once again paying attention to dividends. So should you!

© Dividend Analysis, 2004