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Dividend magic

03 November 2017

Pedestrian as they can appear, dividends end up doing much of the work for long-term equity investors.

Investors in UK-listed companies are on track to receive £94 billion in dividend payouts from companies this year, according to Capita Dividend Monitor1 – a record high.

Yet even in a good year, dividends can appear unexciting – at best, they offer only a few pence on the pound. Then there are the lean years, when a company might not pay anything at all; in the aftermath of the financial crisis, several major banks simply couldn’t afford to. Even if they do pay out, the impact of dividends on your total capital barely seems to move the dial – in the short term.

Yet over the long term something miraculous begins to happen, something that Albert Einstein reportedly called “the eighth wonder of the world”.2 That something is compound interest; and reinvesting dividends achieves a similar effect. The power of compounding lies in the exponential rate at which it increases the value of the initial capital sum over time.

It certainly pays off. Data provided by Morningstar/Ibbotson shows that, between 1926 and 2009, share price appreciation on the S&P 500 averaged 5.47% per year, while dividends delivered 4.13% per year. In short, dividends delivered more than 40% of the total return for investors.3

Past performance is not indicative of future performance.

 

One of the more remarkable implications of this compounding-via-dividends effect is that a temporary fall in the share price can in fact have a silver lining. So long as the company continues to pay a dividend, then the shareholder who reinvests his or her next payment will receive a greater number of shares as a result. Not only does this help to balance out the loss in capital value; it also means the investor is effectively buying up more shares when they are cheaper, yet doing so without committing fresh capital.

As for the size of dividends themselves, figures published earlier this year by Barclays Capital show that dividend growth has remained relatively sustained since World War Two. Five-year growth only dipped briefly into negative territory in the aftermath of the tech bubble – growth even persisted in the aftermath of the global financial crisis.4

The same report shows that, had you invested £100 across UK stocks in 1899, but without reinvesting the income, then, in inflation-adjusted terms, you would end up with £195. If, on the other hand, you had reinvested all the dividend income generated, the figure would be £32,051.5

In short, dividends are far more than a seasonal bonus. Over the long haul, they can even end up doing most of the work.

 

1 http://www.capitaassetservices.com/dividend-monitor-q3-2017
2 It is far from clear that he did in fact say this, but the line has been attributed to him for decades
3 http://business.time.com/2010/02/08/dividends-vs-capital-gains-which-is-better/
4, 5 2017 Barclays Equity Gilt Study, page 145

Some of the products and investment structures documented within this article will not be available to our clients in Asia. For information on the funds that are available please get in touch.

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